Borrowing from your Future
If your eyes have been open the last 15 months of the Covid-19 pandemic, you’ve seen increased marketing for retirement account loans. Brokerage firms make loans against your pension or 401k look easy, simple, and of no real penalty. Such marketing campaigns play on the unlikelihood for consumers to think about the future of their finances more than their present day wants and needs. It’s easier to say, “I need money right now to buy a car, purchase a home, or complete these home renovations. I have time until I’ll need it in retirement. Besides, I’ll be paying myself back when the time comes.” Sound familiar? Today on the ELP Budgeting Services blog, we’ll provide the good, bad, and ugly of retirement loans so you can make the best, educated decision for yourself.
In order for retirement loans to be so attractive, there has to be some “good” about the loan terms, right?
Retirement account loans are often:
- Easy: simple process, often a few clicks of a button.
- Low interest rates: Especially in the current environment caused by the pandemic, interest rates are low compared to outside lenders.
- No credit check: While a bank or outside lender will likely determine eligibility and interest rates with a credit check, most retirement account loans do not.
- Repayment ease: The repayment comes from your paycheck before you even see it.
The Bad (and the Ugly)
At ELP Budgeting Services, we know the importance of presenting all the facts. We’ve presented the “good” in taking a retirement account loan, but let’s take a look at the bad (and frankly downright ugly).
Retirement account loans:
- Decrease opportunity for investment growth:
In the most basic form, retirement accounts are investment accounts. Removing lump sums of money greatly impacts the opportunity for compound interest to work its magic. Compound interest allows your money to grow exponentially in hopes of having enough savings to last through retirement.
- Prevent retirement account contributions:
Many retirement account loans prevent you from contributing to the account until the loan is paid in full. Halting contributions for years, greatly impacts preparation for retirement. With investing, time is money!
- Decrease net pay:
The “good” of repayment ease is also a “bad”. Repaying the loan from your paycheck decreases the money you take home before you can even enjoy it.
- Pre vs. post tax:
When you contribute to your retirement account, it is often with pre-tax money, meaning more bang for your buck. When you repay the loan, it is likely with post-tax money, resulting in even less in your paycheck.
- Pay in full at separation:
Let’s say you take a $25,000 loan with a 5-year repayment term. Two years into the repayment period, with $18,000 remaining on the loan, you receive a dream job offer. Upon your separation, you will immediately be liable for $18,000 or subject to wage garnishment, severe tax penalties and more.
- You’re not just paying yourself back:
You know that interest you’re paying on top of what you borrowed? That is going directly to the lender, not your account. There’s a reason firms want consumers to take loans.
In conclusion, when it comes to your money you have to decide what is the best decision.
Alternatives to a lump sum retirement account loan include:
- Saving up by aggressively following an ELP Budgeting Services monthly budgeting plan.
- Selling an asset to generate cash.
- Considering affordability or necessity for the item requiring a loan. Adjust priorities and timing accordingly.
- As a last resort, seek outside funding that does not directly prevent retirement saving.