If there’s any financial rule everyone has heard, it’s that borrowing money from a retirement plan is akin to financial blasphemy. That goes doubly if an employer matches contributions to the plan. But desperate times call for desperate measures. Sometimes life presents an unsavory choice: borrow from retirement savings or go truly, irreversibly broke. What then?
Here’s what to consider before you borrow from your retirement savings account.
What is the actual cost of borrowing?
When you borrow from your retirement account, you’re losing more than just the cost of the loan. You’re losing the interest you’d yield from the money. You’re losing savings time. And you may be losing an employer’s contribution to your account. When calculating whether the loan is worth it, and how much it costs as compared to other options, take these factors into account. If you’re contemplating borrowing a large sum, it may even be worthwhile to meet with a financial advisor to assess whether a loan from your retirement account is your only, or best, option.
Can you repay the money? Will you?
Before taking a loan from your retirement account, ask yourself whether this is really a loan. Can you repay the amount, with interest, while also making contributions in the future? If not, then you must treat the money as a permanent loss to your future self. Make your calculations about whether to take the money with that in mind.
Before you take the money, devise a comprehensive plan for repaying the loan. This plan should be a realistic one, based on your current expenses and income—not a fantastical projection of a wealthy future with few or no expenses.
Are you losing free money?
If you don’t max out your employer’s matching contributions to your retirement account, you’re basically lighting free money on fire. When you take out money your employer has contributed, you’re doing the same. Think carefully about the costs of removing this money from your account, and weigh the decision against the value of the loan to your life and financial well-being.
Is there a better option?
A loan from your retirement account should be considered an option of last resort. Don’t even think about borrowing from your retirement future until you’ve explored other options. Ask yourself the following questions:
- Can I take out a loan with interest that is lower than the loss I’ll take on a retirement loan?
- Is there another way to fund this need, such as by working overtime hours or getting help from a family member?
- Is this something I absolutely need?
If you’re already retired and own your home, consider a reverse mortgage. If you follow the terms of the loan, you can access cash without having to repay the loan, so long as you remain in your home.
Is it a matter of life and death?
If there’s no other option for funding something that is truly a matter of life and death—rehab for a child who is addicted to drugs, treatment for cancer, an organ transplant—then no other consideration matters. You won’t be here to enjoy your retirement savings if you don’t tend to the needs of life today. So if it’s a true matter of life and death and there’s no other option, go ahead and take the loan.
How will this affect me?
Even if you think you can repay the loan, don’t borrow from your retirement if you think you’ll be haunted by stress and guilt. Negative emotions about the loan can actually undermine your ability to repay it, so be honest with yourself about how the loan will affect your emotions and behavior.