YOUR MONEY


Don’t Risk Your Retirement!


Read this before you borrow from your 401(k). ::


BY DANIELLE BRAFF I


f you need cash for an unexpected expense, you may find yourself considering borrowing from your 401(k). Loans from 401(k)s have grown in popularity in


recent years, according to Empower, a financial services administrator that analyzed its 5.3 million accounts. About 138,000 people — or 2.6% of Empower’s savers —


took out a retirement loan in the third quarter of 2023. The average amount borrowed? A not insignificant $11,000. While borrowing from your own retirement plan may


seem easier and cheaper than getting a loan from a bank, especially if you intend to pay yourself back as soon as your finances stabilize, there are risks. The biggest one? The high cost of default. If you don’t pay the loan back, the outstanding balance


will be treated as a distribution, meaning you’ll have to pay taxes on it at ordinary rates. What’s more, if you’re younger than 59 and a half, you will also have to pay a 10% early withdrawal penalty on the amount you didn’t return to the account. You may also run into big problems if you lose your job.


Most retirement loans have an accelerated loan repayment schedule compared to the typical car or personal loan. That makes the loan payments higher, which makes it more likely you could have trouble repaying it. If you can’t repay the loan in the accelerated time frame, it will be considered a taxable distribution.


NEGATIVE SPIRAL In addition, borrowing from a 401(k) could have a domino effect on your finances if repayment becomes difficult. As noted above, any unpaid loan balance will be


considered a distribution, which would trigger taxes and penalties. But that’s not all . . . those taxes and penalties could cause you to have trouble meeting other financial


obligations. If that happens and you start missing payments on other debts, your credit score will drop. Then there’s the issue of your retirement. Borrowing


from your future self means you could miss out on important investment growth, says Javarah “Jay” Joseph, a chartered retirement planning counselor (CRPC). Over time, this could significantly impact your retirement savings. Say, for example, you have $500,000 in your 401(k),


growing at 7% annually, and need to borrow $11,000. Withdrawing that amount and not paying it back would result in a loss of $22,350 in growth over 10 years. And if you do pay it back, you’ll likely be double taxed


on part of that money. Remember, you funded your 401(k) with pretax dollars, so when you withdraw money from your 401(k) at retirement, that money will be completely taxable at your ordinary income tax rate. The problem is when you repay a 401(k) loan, you’ll


most likely use after-tax dollars. So, you’re putting after- tax dollars into your 401(k) to repay the loan — then, when you withdraw that money at retirement, you’ll be taxed again.


There are also costs to borrow from a 401(k), just like


there are costs to take out regular loans. Some plans charge an origination fee, which is a percentage of the


The problem is when you repay a 401(k) loan, you’ll most likely use after-tax dollars. So, you’re putting after-tax dollars into your 401(k) to repay the loan — then, when you withdraw that money at retirement, you’ll be taxed again.


74 NEWSMAX MAXLIFE | AUGUST 2024


VITALII VODOLAZSKYI/SHUTTERSTOCK


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