When they run up against a financial hurdle, the solution for many people is to borrow money from their retirement savings.
In a survey, some 29 percent of Americans told financial services giant TIAA-CREF that they have borrowed from their retirement plans. Of those, 43 percent said they had taken out two or more loans.
In the best of all possible worlds, no one would find themselves in a situation where they need to borrow money from their future to pay current obligations. But as we all know, things happen, and there are some situations in which borrowing from your retirement savings can be better than other alternatives. But before you put your retirement planning at risk, here are some things to think about.
When not to use your 401(k) as a piggy bank
Dan Keady, a certified financial professional and director of financial planning for TIAA-CREF, which manages retirement plans for nonprofit and government enterprises, says "Used correctly, it may OK, but too many people get in the habit of using their 401(k)s like a piggy bank."
Given the inevitability of unpredictable demands for money, the best solution is to have an emergency fund and take money from that, Keady says.
The worse solution is taking out a high-interest payday-type loan. Borrowing from your 401(k) or 403(b) is somewhere in between. If you must do it, ask yourself these questions first:
Is this really an emergency? Would applying a little self-discipline be a better solution? Keady says too many people borrow to pay off other debt. "It isn't a real emergency. They're borrowing because their budgets are out of kilter."
Are you a good credit risk? No one checks your credit rating when you take out a retirement loan. But when you're considering being both lender (since the loan is coming out of your retirement account) and borrower, you should assess the possibility that you might be unable to pay the money back. If you quit or lose your job, you'll face taxes and -- if you are younger than 59 1/2 -- a 10 percent penalty unless you find the money elsewhere to repay yourself.
Is the rate too high? On the surface, 401(k) loans are good deals because the interest rate you charge yourself is lower than you'd pay elsewhere. But there are related issues to consider. About 57 percent of borrowers cut their 401(k) contribution rates during the payback period, TIAA-CREF's study found. So the net result was greatly reduced retirement savings. Given that, can you really afford this loan?
How close are you to retirement? Borrowing against your retirement fund just when you might need it to live on is certainly a bad idea.
Whether or not you ultimately decide to take out that loan, paying attention to the health of your 401(k) is always smart. Here are some ideas for picking funds.