When Is It OK to Borrow from Your Retirement Plan?

So you’re facing an extraordinary expense and you’re thinking about borrowing from your retirement plan? Before you do that, it’s a good to think about the consequences. After all, this is your retirement money that you’re touching.

Here’s when it’s okay to borrow from your retirement plan.

When You’re at Your Wit’s End

If you have very little savings in the bank, you’ve maxed out your credit cards, and you’re desperately in need of some cash for an emergency expense, then it’s acceptable to borrow money from your retirement plan.

Keep in mind, though, that if you’re borrowing from a 401k or 403b retirement plan, that plan is tied to the company that employs you. If you decide to leave that company before you’ve paid off the balance, then you’re going to face another financial hurdle as you’ll likely need to pay the loan balance in full when you exit or accept the money as a distribution.

However, if you’re borrowing from an IRA, you won’t face that kind of restriction. That’s why it might be preferable to borrow from an IRA instead of a retirement plan tied to your place of employment.

When It Has the Lowest Rate

If you’re credit isn’t that great, then borrowing money from your retirement plan is probably your best loan option because it’s likely to give you a lower rate.

Keep in mind, though, that if you started retirement planning early, you might have a sizable nest egg in place. If you borrow a significant percentage of that money, and can’t pay it back, then you’re probably going to end up taking an early distribution from your retirement account. That means you’ll have to pay taxes on the amount that you withdrew as well as a 10% penalty.

The bottom line is that you want to be extremely careful before you borrow from your retirement plan. It could actually put you in a worse financial position if you can’t pay the money back.

When Your Job Is Secure

If you’re fairly certain that you’re a “lifer” at your job, then feel free to borrow money from your retirement account.

As we’ve seen, your 401k or 403b account is tied to your work. So, if that’s the retirement plan that you intend to borrow against, and you know you’re staying there for a while, then your risk is fairly minimal.

Also, job security gives you some peace of mind that you’ll be in a position to pay back the loan over time. That also reduces the risk that you’ll have to take a distribution.

On the other hand, if your boss has been expressing misgivings about your work lately and there’s rumors of looming layoffs, then it’s probably best if you explored other options as opposed to borrowing against your retirement plan.

There are times when it’s acceptable to borrow from your IRA, 401k, or 403b. Exercise some up front due diligence and proceed with caution as you touch your retirement savings for important emergency expenses.