NCPA - National Center for Policy Analysis

401(K) LOANS = RETIREMENT INSECURITY

April 25, 2008

The primary disadvantage of taking a 401(k) loan is the loss of compound interest and dividends that would have accrued if the money had not been borrowed.  Moreover, the interest paid back into the account is unlikely to equal the interest earned by 401(k) investments.  A $30,000 loan could cost a worker more than $600,000 in retirement in-come, say Robert Reeves, an intern and Pamela Villarreal, a policy analyst with the National Center for Policy Analysis.

Consider what happens when a 35-year-old worker with a 401(k) account balance of $60,000 borrows $30,000 at an interest rate of 6.25 percent to be paid back over two years.  Assume the worker normally contributes $500 a month to the account but cannot do so during the loan repayment period, either because the plan doesn't allow it or he cannot afford it.  Instead, he makes after-tax monthly loan payments of $1,333 (including interest).  For instance:

  • If the account were earning a market interest rate of 6.25 percent, the same as the loan interest rate, he would have more than $87,000 less at retirement (age 67) than if he had not borrowed.
  • If the account were earning a market interest rate of 10 percent, he would have more than $307,000 less at retirement than if he had not borrowed.

Next, consider a scenario in which a worker borrows $30,000 over a five-year period, with monthly payments of $583.  Assuming no pretax contributions are made during the loan repayment period:

  • If the account were earning a market interest rate of 6.25 percent, he would have $192,794 less at retirement (age 67) than if he had not borrowed.
  • If his account were earning a market interest rate of 10 percent, he would have more than $646,200 less at retirement than if he had not borrowed!

Source: Robert Reeves and Pamela Villarreal, "401(k) Loans = Retirement Insecurity," National Center for Policy Analysis, Brief Analysis No. 615, April 25, 2008.

For text:

http://www.ncpa.org/pub/ba615/ 

 

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