Generally speaking, taking out a 401(k) loan is a horrible idea, but sometimes you simply have no choice. What are the pros and cons of a 401(k) loan, and when is it actually okay to sacrifice some of your retirement savings for money you can use today?
"Many people don't have enough saved for retirement in the first place, and when they take their 401(k) out of the equation and borrow the money -- typically up to 50 percent of their balance -- then that money is no longer working for their retirement needs," says financial planner Bob Mecca, president of Robert A. Mecca Associates in Prospect, Ill. "And the money is no longer growing, compounded and tax-deferred."
Of course, it's best to avoid such a moment of desperation in the first place. Having an adequate emergency fund in reserve is a good way to steer clear. But let's say you're out of cash and you seem to be out of options for acquiring what you need. In this short list of scenarios, a retirement account loan might make sense.
You have no other recourse
Don't touch your 401(k) until you have at least considered alternatives such as a home equity line of credit or borrowing from a family member, Mecca says.
Joel Larsen, principal of Navion Financial Advisors in Davis, Calif., insists that about the only situation desperate enough to justify a retirement account loan is one where "you have no money, you can't keep the lights turned on and you can't buy groceries." For everything else, you can negotiate.
"Even though what's facing you today can look pretty ugly, like when you can't pay your credit card bills, those can be negotiated," Larsen says.Feeling pressure because of harassing phone calls from creditors? Send them a certified letter requesting they stop calling. Too many medical bills? Try to work out an arrangement to pay them over time before you tap into your retirement account. Even if your creditors refuse to negotiate, if you continue to make at least a partial payment each month, you won't be in default.It's the lowest-cost loan availableRobert Gordon, senior financial adviser with Investor Solutions in Coconut Grove, Fla., says a 401(k) loan could be a useful option for people who have problems getting credit at affordable rates -- for example, someone whose credit score has plummeted because of bankruptcy or a short sale."When they get ready to go into the market, instead of subjecting themselves to two (percent), three (percent) or four percentage point increases in rates or not getting credit at all, (a 401(k) loan) could be a resource," Gordon says.Just remember that the interest you save by choosing a 401(k) loan over a bank loan still may not be enough to make up for your loss of earnings from taking the money out of your retirement account.Bankrate's 401(k) loan calculator shows you how much your retirement nest egg stands to lose if you borrow from your 401(k). Next >Bankrate.com is the Web's leading aggregator of information on financial products including mortgages, credit cards, new and used automobile loans, money market accounts, certificates of deposit, checking and ATM fees, home equity loans and online banking fees. Visit Bankrate.com to get the tools and information that can help you make the best financial decisions.