Home About Archives RSS Feed

The Independent Investor: Don't Take Loans From Your Tax-Deferred Accounts

By Bill SchmickiBerkshires columnist
It sounds too good to be true. Why borrow from a bank when you can take a loan out from your 401(k) or 403(b) and pay yourself back in both interest and principal? If that sounds like a great deal, it's not.
 
Money purchase plans, profit-sharing plans, 457(b) plans and both 401(k) and 403(b) plans may offer loans, but IRAs, SEP IRAs, and SIMPLE IRAs do not. The IRS does have some restrictions on the borrowing. It limits how much you can borrow at any one time. In general, you are limited to the smaller of 50 percent of your vested account balance, or $50,000. However, there is one exception (hardship) that allows you to borrow up to $10,000 even if it exceeds 50 percent of the balance. It also requires you to pay yourself a reasonable rate of interest on your loan. Generally, you have five years to repay the loan, although you are required to pay at least quarterly payments.
 
Recently a thirtysomething-year-old client told me he had taken out a $7,000 loan from his $50,000 403 (b) tax-deferred retirement plan years ago. He was surprised to find that it was not an interest-free loan and that he was required to pay off the loan in its entirety before he could draw from the account in retirement. What's worse, if he quit his job, his company required that he pay off the amount in 60 days. He thought it was the IRS that laid down the rule provisions, but that is not the case.
 
It is the company you work for that offers the plan. Some companies won't let you borrow. Others have limitations on how much much you can borrow and how much you pay in interest. What happens if you fail to repay the loan? The IRS will consider the loan a distribution from your plan. You will then need to pay income tax on the amount, plus a 10 percent penalty if you are not age 59 1/2 or older. 
 
There are only a few cases where borrowing from your tax-deferred account makes economic sense: If you have an immediate emergency, say a medical issue, that cannot be financed any other way, an immediate cash obligation and your credit score prevents you from borrowing in any other way, or an extremely high interest debt that is threatening to send you into bankruptcy, or worse, may require you to take out a loan.
 
Nearly 3 out of 10 Americans borrow from their retirement plans. The problem is that they erroneously view them as their own personal piggy bank, until something goes wrong. If you lose your job, for example, you not only have no income coming in, but the loan is due in 2-3 months. If you can't pay it back, you get slapped with additional taxes (as a distribution), which, unless you have a new job lined up, has to be paid out of whatever you have in your checking account.
 
Since these loans are paid back with your after-tax dollars, you end up paying taxes on the money twice. Once, out of your paycheck, to repay the loan and a second time, when you start withdrawing money in retirement.
 
Finally, these plans were established to provide you a winning combination of tax breaks, company matches, and the compounding of gains from your contributions, so that you can save for retirement. None of that occurs while you have a loan outstanding. Instead of a contribution each quarter, the loan repayment is taken out of your paycheck each quarter.
 
If you take the full five years to repay the loan, not only are you missing out on five years of savings and compounding, but also the opportunity costs that the markets provide you.
 
Bill Schmick is registered as an investment adviser representative and portfolio manager with Berkshire Money Management (BMM), managing over $400 million for investors in the Berkshires.  Bill's forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquiries to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com.
 

 

0 Comments
     

Support Local News

We show up at hurricanes, budget meetings, high school games, accidents, fires and community events. We show up at celebrations and tragedies and everything in between. We show up so our readers can learn about pivotal events that affect their communities and their lives.

How important is local news to you? You can support independent, unbiased journalism and help iBerkshires grow for as a little as the cost of a cup of coffee a week.

News Headlines
At 100, Navy WAVE & MCLA Graduate Remembers Where It All Began
Hoosac Valley Athletic Director Molly Meczywor Getting EMT Certification
North Adams Library Suspends In-Person Events
Bromley's 'Momís Day Off' Cancer Fundraiser
Great Barrington Working on Public WiFi Network
Realty Agent Ranked No.1 in Sales for 2021
Cold Blast to Start the Weekend, Snow Expected to End It
Dalton Selectman Boyle Proposes Merger of Development Panels
Berkshire Art Association Extends Application Deadline for Festival
CHP Hosts Support Group for Parents of Children with Special Needs
 
 


Categories:
@theMarket (396)
Independent Investor (451)
Retired Investor (75)
Archives:
January 2022 (4)
January 2021 (4)
December 2021 (9)
November 2021 (7)
October 2021 (8)
September 2021 (9)
August 2021 (6)
July 2021 (8)
June 2021 (6)
May 2021 (6)
April 2021 (9)
March 2021 (8)
February 2021 (8)
Tags:
Debt Ceiling Election Japan Debt Europe Currency Stimulus Selloff Congress Metals Jobs Markets Interest Rates Banks Wall Street Recession Bailout Greece Euro Fiscal Cliff Federal Reserve Retirement Rally Housing Stock Market Pullback Europe Commodities Deficit Crisis Energy Economy Taxes Oil Stocks
Popular Entries:
The Retired Investor: The Hawks Return
The Retired Investor: Has Labor Found Its Mojo?
The Retired Investor: Time to Hire an Investment Adviser?
The Independent Investor: Don't Fight the Fed
The Retired Investor: Climate Change Is Costing Billions
The Retired Investor: My Dog's Medical Bills Are Higher Than Mine
@theMarket: Let the Good Times Roll
Independent Investor: Europe's Banking Crisis
@theMarket: One Down, One to Go
@theMarket: 707 Days
Recent Entries:
@theMarket: Beware the Hikes of March
The Retired Investor: No-Shows Threaten Economy
@theMarket: Fed Meeting Notes Throw Markets a Curve
The Retired Investor: My Dog's Medical Bills Are Higher Than Mine
@theMarket: Markets Up on Thin Holiday Trading
The Retired Investor: Climate Change Is Costing Billions
@theMarket: Markets Are Heading for Trouble
The Retired Investor: Time to Hire an Investment Adviser?
@theMarket: Markets Keep Churning
The Retired Investor: Has Labor Found Its Mojo?