Retirement: Dipping into a 401(k)

“Financial planners certainly don’t promote” borrowing from your 401(k) account, said Rodney Brooks in USA Today. But once other options are exhausted, “sometimes you really don’t have a choice.” One in five 401(k) account holders currently has an outstanding loan. Some manage those loans prudently, but many do not. If you have to crack your nest egg, make it your last resort, know your limits, and be disciplined about repaying the loan. Most plans will let you take out up to $50,000, which must be repaid within five years unless the money is spent on a principal home. While interest rates as low as 4.25 percent can be tempting, there are grounds for wariness: “If you leave your job, you’ll have to repay the loan immediately or pay taxes on the remaining balance.” You should consider the economic cost of losing earnings for your future while you pay interest today. Borrowing from your 401(k) may be justified if you need the cash for an emergency, but it rarely makes sense just to pay off credit card debts or college costs.

Whatever you do, don’t succumb to the temptation to become a “serial borrower,” said Tara Siegel Bernard in The New York Times. A recent study by Fidelity found that many workers who borrow from their retirement accounts just can’t stop. Borrowing from a 401(k) seems attractive because the interest rates are low and loans don’t incur the 10 percent penalty triggered by an early cash-out. But repeat borrowers can do permanent damage to their nest eggs, especially if they “cannot continue to save as much while they pay the loan back.” Fidelity’s study found that as borrowers accumulate more loans, they tend to dial back their savings and therefore earn less for retirement.

Maybe you shouldn’t have a 401(k) in the first place, said Cliff Goldstein in MarketWatch.com. Financial gurus preach that maximizing your 401(k) contribution “is a surefire way to secure a prosperous life after work,” but it isn’t for everyone. If you don’t have an emergency fund—about six months of income—on hand, consider building one up before you start contributing to a 401(k). And you should prioritize paying down your debts. “Investing in a 401(k) is a great way to grow your money, but it won’t do much good if debt is simultaneously eating away at your accounts.” If your company has a generous 401(k) match, by all means take advantage of it. But if not, consider trading your 401(k) for a traditional or Roth IRA, which may offer better investment options—and more bang for your buck.

Subscribe to The Week

Escape your echo chamber. Get the facts behind the news, plus analysis from multiple perspectives.

SUBSCRIBE & SAVE

Sign up for The Week's Free Newsletters

From our morning news briefing to a weekly Good News Newsletter, get the best of The Week delivered directly to your inbox.

From our morning news briefing to a weekly Good News Newsletter, get the best of The Week delivered directly to your inbox.

Sign up