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
MCLA Women Fall at Anna Maria
Williams Men's Soccer Reaches National Title Game
Stockbridge Main Street at Christmas Returns
City Council OKs Starbucks on South Street
Ticking Clock: Behind the Scenes at 60 Minutes with Ira Rosen
MEMA Eyes Western Mass for Abandoned Migrants
Dalton Firefighters Extinguish Zinky's Pub Stove Fire
New Staff and Board at Nonprofit Center
Penny Social, Non-Profit Fair Returns at Williamstown's Holiday Walk
Berkshire County Officials to Work Friday Game at Gillette Stadium
 
 


Categories:
@theMarket (430)
Independent Investor (451)
Retired Investor (119)
Archives:
December 2022 (1)
December 2021 (9)
November 2022 (7)
October 2022 (8)
September 2022 (9)
August 2022 (5)
July 2022 (7)
June 2022 (7)
May 2022 (7)
April 2022 (8)
March 2022 (9)
February 2022 (7)
January 2022 (7)
Tags:
Jobs Taxes Bailout Stocks Deficit Stimulus Markets Greece Interest Rates Retirement Economy Currency Pullback Banks Federal Reserve Europe Recession Stock Market Congress Crisis Europe Employment Debt Ceiling Debt Japan Oil Election Selloff Fiscal Cliff Euro Commodities Metals Banking Rally Energy
Popular Entries:
The Independent Investor: Don't Fight the Fed
Independent Investor: Europe's Banking Crisis
@theMarket: Let the Good Times Roll
Independent Investor: Enough Already!
@theMarket: Let Silver Be A Lesson
The Independent Investor: Japan — The Sun Is Beginning to Rise
Independent Investor: What To Expect After a Waterfall Decline
@theMarket: One Down, One to Go
@theMarket: 707 Days
The Independent Investor: And Now For That Deficit
Recent Entries:
The Retired Investor: Inflation Versus Wages
@theMarket: Investors Await Inflation Data
The Retired Investor: Time to Rebuild the Strategic Petroleum Reserve?
@theMarket: Markets on Hold
The Retired Investor: U.S. Veterans Gaining Jobs
The Retired Investor: Inflation Hits COVID Dog Owners
@theMarket: No Pause, No Pivot, Says Fed
The Retired Investor: Economics of Daylight Savings Time
@theMarket: Markets Consolidate Before the Fed
The Retired Investor: Halloween Spending Should Hit Record Year