The CARES Act makes it easier to borrow from your 401(k).
THE CORONAVIRUS AID, Relief, and Economic Security Act of March 2020 doubles the amount retirement savers can borrow from a 401(k) plan. But that doesn’t necessarily mean you should raid your future retirement savings, even during the coronavirus pandemic.
“If we weren’t in this crisis moment that we are in today, typically I would advise not to be tapping into your 401(k),” says Rhian Horgan, CEO and founder of the retirement planning platform Kindur in New York City. “That money is your future paycheck. Those funds will not be growing while money is out of your account.”
Here’s how to decide whether to take a 401(k) loan to cope with coronavirus costs:
- You can borrow up to 100% of your vested account balance up to $100,000.
- Losing your job could make a 401(k) loan become due sooner.
- A 401(k) loan could cause you to miss out on the stock market recovery.
- Compare the terms of a 401(k) loan to other types of loans.
Some people may need to tap a retirement account to get through coronavirus-related financial uncertainty. Here’s what to watch out for when initiating a 401(k) loan.
Higher 401(k) Loan Limits
Previously, 401(k) plans that allowed loans permitted participants to borrow a maximum of $50,000 or 50% of the account balance. The CARES Act increases the maximum 401(k) loan to $100,000 or 100% of the vested account balance. Additionally, workers with existing 401(k) loans that are due in 2020 are eligible to delay repayments for one year.
While 401(k) account owners now have the option to initiate bigger loans, many financial advisors recommend against 401(k) loans except in cases of last resort. “As a rule of thumb, you shouldn’t touch your retirement account until you retire,” says Matt Sadowsky, director of retirement and annuities at TD Ameritrade. “You should keep money in the account and enjoy tax-deferred growth.”
Think About Whether You Will Lose Your Job
Recipients of a 401(k) loan generally need to pay back the entire balance within five years with interest. However, if you lose your job, the loan could become due sooner. Any outstanding balance on the loan that you cannot repay becomes a 401(k) distribution and could be subject to income tax and the early withdrawal penalty. Think about the financial health of your employer and whether there are likely to be layoffs in the near future before initiating a 401(k) loan.
Missing Out on the Recovery
The stock market decline has caused many 401(k) plans to lose value. Removing funds from a depleted 401(k) account could mean selling investments at a loss and failing to benefit from the recovery. “Taking assets out when the market is down, even a loan, you’re going to miss the rebound,” says Jeff Schneble, CEO of Human Interest, a 401(k) provider in San Francisco. “We know the market will come back. If you take money out at the bottom, you will not get to take part in that recovery.”
Consider 401(k) Loan Alternatives
Compare the costs of a 401(k) loan to other types of loans you might be eligible for, such as a home equity loan. “People who are unemployed could take a personal loan or money out of a house, and then you are not selling assets at the bottom of the market,” Schneble says. Look at the fees and interest rate of each type of loan you are considering.
Borrowers can gradually repay a 401(k) loan amount to their retirement account. “The positive of borrowing against your 401(k) versus other credit strategies is that it doesn’t have an impact on credit rating, and the interest you pay goes back into the retirement account,” Horgan says. “What you are giving up is the return on investment earnings.”
A 401(k) loan is likely to be a better option than high interest credit card debt. “It is a tough argument to say you should borrow on a credit card, with high interest, rather than your retirement account,” Sadowsky says. “If you have a true hardship and you really need that money in an emergency, (a 401(k) loan) is a resource.”