NCPA - National Center for Policy Analysis

BORROWING FROM YOUR 401(K)? DO THE MATH FIRST

August 4, 2008

Experts warn that taking money out of your 401(k) account while you're still working can cost you dearly later on.  Financial advisors say the weak economy and credit crunch are likely to push more Americans to prematurely tap their retirement savings.  Statistics indicate that borrowing and so-called hardship distributions from retirement plans are creeping up, said Rob Reiskytl, a senior consultant at Hewitt Associates in Chicago.

Either action can have significant long-term consequences, potentially costing the consumer hundreds of thousands of dollars over time. And be aware that taxes and penalties can eat up more than 40 percent of your distribution.

Loans from 401(k) plans have two advantages:

  • The rates are low -- usually a percentage point or two over the prime rate.
  • And your payments, including the interest, typically go directly back into your account after a small deduction for processing.

According to Pam Villarreal, a policy analyst with the National Center for Policy Analysis (NCPA), even a small loan can cause a big loss in retirement security.  For example:

  • A 35-year-old who borrows $30,000 and repays it over five years could be $193,000 poorer at retirement, assuming that he or she didn't make new contributions while repaying the loan and the 401(k) investments earned a 6.25 percent average annual rate of return.
  • If you assume a 10 percent rate of return, the loan would cost that 35-year-old nearly $650,000 at retirement.

You can run your own numbers using the NCPA's 401(k) Borrowing Calculator at: http://retirementreform.org/.

Source: Kathy M. Kristof, "Borrowing from your 401(k)? Do the math first; Taking out a loan could cost you in the long run, so be sure to calculate the consequences," Los Angeles Times, August 3, 2008.

 

Browse more articles on Economic Issues