401(k) Loans: 4 Reasons to Take One Out

401(k) Loans: 4 Reasons to Take One Out

Pejorative phrases have been coined by the financial media to describe the risks associated with borrowing money from a 401(k). There are those—including financial planners—who want you to believe that using a 401(k) plan for a loan is committing a crime against your retirement.

However, a 401k loan can be appropriate in some circumstances. Here’s how a loan of this type could be used sensibly and why your retirement savings need not be harmed.

The case for 401(k) loans

401(k) plan loans are probably one of the first places you should consider if you need money for a short-term liquidity need. Approximately one year or less would be considered short-term. For purposes of defining “serious liquidity need”, we will consider funding demands or lump-sum cash payments as serious one-time demands.

Short-term loans are an excellent source of funding from your 401(k). Getting cash fast, easily, and at the lowest cost is the fastest and simplest way to get it. Unless you violate the loan limits or repayment rules, receiving a 401(k) loan is not a tax-deductible event or affects your credit rating.

Your retirement savings progress will not often be adversely affected by a short-term loan if you pay it back on schedule. The impact can even be positive in some cases. Let’s take a closer look at why.

Borrowing from your 401(k) for these 4 reasons

If you need short-term cash, consider your 401(k) for the following four reasons:

Taking money out of your 401(k) in retirement | John Hancock Retirement

1. Quickness and Convenience

An application for a loan in a 401(k) plan is typically easy and quick, without requiring a lengthy credit check or lengthy application. In most cases, it does not affect your credit rating or cause an inquiry to be filed against your credit.

There are many 401(k) plans that allow loan requests to be made via a website in a few clicks, and the funds can be in your hand in a matter of days. In some plans, a debit card allows instant loans to be made in small amounts and multiple loans can be made simultaneously.

2. Flexible repayment options

Even though 401(k) loans are supposed to be repaid over a five-year period, you can usually repay the plan loan quicker without penalty. Although most plans allow you to repay your loans using after-tax dollars, not the ones you used to fund them, you can make it convenient by taking payroll deductions. Just like a regular bank loan statement, your plan statements indicate credit to your account and your remaining balance.

3. Cost Advantage

Using your own 401(k) money for short-term liquidity needs incurs no cost (other than perhaps loan origination or administrative fees). The process typically goes like this:

When you borrow money from an investment account, the account(s) are liquidated while the loan is in effect. Therefore, you lose any earnings from those investments that were expected to appear in a short period of time. When the market is down, you are able to sell your investments for a lower price. Another benefit is that you avoid future investment losses with this money.

4. Savings for retirement can be beneficial

Generally, 401(k) loan repayments go back into your portfolio’s investments as they are made. As a result of the loan, you will repay the account a bit more than you borrowed from it. The difference between the two payments is known as “interest,” and the loan has no (i.e., no) effect on your retirement planning if lost investment earnings offset interest payments dollar for dollar.