The Truth and Consequences of Plan Loans

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By Richard C. St. Onge, PPC

If you are like the many working Americans, your employer offers a defined contribution retirement plan, such as a 401(k) or 403(b), which allows you to defer amounts from your salary for future retirement savings.  Many of these plans offer loan provisions which allow employees to borrow back their own contributed dollars should such the need arise.  But what are the consequences of taking such plan loans and is it ever a good idea?

In the retirement plan industry, the larger an employer’s aggregate plan size, typically the lower the overall costs.  So employers and plan participants benefit by having larger plans and increasing the participation rate increase within the plan.  In order to spur investment, a loan provision offers a line out in case of emergency or hardship because, after all, people are a lot more willing to put money in if they can take it out again.

While taking a plan loan generally comes with fewer immediate consequences than a withdrawal, there are specific pitfalls in borrowing against your retirement.

Whether a loan is justifiable or not tends to be subjective.  For some, perhaps taking a loan from a 401(k) for education costs or a down payment on a home makes sense.  But often, material purchases like a new car or kitchen can seem like great ideas at the time, too.  Before considering a plan loan, consider your likelihood of repaying it, whether your intention for the funds is for a necessity (or not), and whether you understand the impact on your long-term savings.  You should always consult with your tax preparer prior to taking any withdrawals, and be sure to consult with your plan administrator or review your plan’s Summary Plan Description (SPD) for the specifics of your company’s retirement plan.

Basic facts about 401(k) plan loans:

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.