If your financial life has hit a rough patch, you may be thinking about taking a loan from your 401(k) savings plan.
Yet is it the right move to make?
Many financial experts typically advise against it, calling it a "last resort."
However, with the coronavirus pandemic causing layoffs and furloughs, many people are scrambling for ways to pay their bills. More than 10 million Americans have filed for unemployment over the past two weeks.
"You are borrowing from your future," said certified financial planner Diahann Lassus, president and chief investment officer of Lassus Wherley, Peapack Private Wealth Management. "It increases the risk of not being able to meet your long-term goals.
"If you exhaust everything else and you don't have any other way to meet your bills or keep a roof over your head, this would be an option," said Lassus, a member of the CNBC Financial Advisor Council.
A 401(k) is how many Americans save for retirement. It is funded directly through payroll deductions, and employers often offer some sort of matching contribution.
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Typically, you can take a loan of up to $50,000 or 50% of your vested account, whichever is less. However, last week President Donald Trump signed the $2 trillion coronavirus relief bill — the CARES Act — into law, which temporarily doubled that amount to $100,000. The term of the loan is usually five years.
Alternative options
Before you take out a 401(k) loan, research all of your alternatives, said Nathan Voris, senior managing director of business strategy at Schwab Retirement Plan Services. Schwab currently has 1.6 million 401(k) participants.
"Debt isn't always the answer," he said.
He suggests "taking that step back and taking that breath and having a consulting session focused on your full financial wellness to understand what your options are."
That could include reaching out to your lenders and mortgage company to see if you can postpone a payment or come up with payment plan strategies to help you through this time.
When it comes to raising cash, first check around for any other assets you may have, like a mutual fund or a stock, said Lassus. Even if you sell at a loss, you can take the tax write-off.
If you own a house, you can tap into its equity with a home equity line of credit.
"A HELOC, which is like a second mortgage on your house, could potentially give you access to dollars at a reasonable cost these days, given interest rates are so low," Lassus said.
Currently, rates range between 2.87% and 21%, depending on the borrower's creditworthiness, according to BankRate.
If you don't have a home, you can shop around for a low-interest-rate personal loan.
On the other hand, personal lines of credit, which are an open credit line versus a one-time loan, tend to have higher rates because they are much riskier for the bank. In that case, a 401(k) loan may be the better option, said Lassus.
Another solution could be going to a family member for a temporary loan.
"You have to make sure you have a written agreement and loan payment schedules to make sure you don't mess up the family relationship," Lassus said.
Stay away from high-interest rate loans, such as payday loans or cash advances from your credit card.
Taking a 401(k) loan
If you opt to take a 401(k) loan, make sure that your company actually offers you the option, as not all do.
If they don't, speak with your employer. The CARES Act allows retirement plans to adopt the rules immediately.
Then, determine how much you'll need. Think long-term, not just a short-term solution like covering a month's rent. However, don't go overboard.
"How much do you absolutely have to have? Don't just don't look at the $100,000 available and take it," Lassus said.
"The less you take, the better off you are because there are other risks around this."
You'll sign a loan agreement and have to be approved. In most cases you will be, since you are borrowing your own money, according to Finra.
Also remember that you will be paying market interest rates on the loan. The money comes from your account balance, which means in many plans it is taken from equal portions of your different investments.
Beware of potential pitfalls
The biggest risk is that you default on your loan.
You may have the best of intentions to pay it back, yet "a lot of times life doesn't go as planned," said Voris.
"We do see that a lot of folks don't pay them back," he said.
If that happens, you'll be slapped with a 10% early withdrawal penalty and taxes on the money taken from the account. Your defaulted loan isn't converted to the up to $100,000 withdrawal you are allowed to take penalty-free through the CARES act, according to Schwab.
That means assess your job. Are you in danger of being laid off, or do you plan to leave before the loan term is up? If so, you may want to find another source of cash. You'll be required to pay the outstanding balance of the loan.
There is also a "downstream effect," Voris said.
When you take money out of your account, it won't be earning you any interest towards your retirement. Plus, employees often stop contributions to their 401(k) when they have a loan out, he said. If that happens, then they miss out on the employer's matching contribution
"That really affects your long-term calculations," Voris said.
However, despite the downsides, a 401(k) loan may be the only option.
"The reality is what we are facing right now reminds us that very often the 401(k) is the largest and most important, and often the only, bucket of money that the average American has accumulated," Voris said.
"It's their money and, in times of need, they should be able to access it in a simple and easy way."
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