Should you borrow from your retirement plan?


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If you need money to cope with an unexpected expense, to pay down debt or to afford a big expense such as a wedding or college tuition, taking a loan from your workplace retirement plan may seem like a good option. After all, retirement is years away for many people, and it may feel like you have plenty of time to rebuild those savings.

However, taking a loan from your retirement plan today can hurt you in the long run, including possibly lowering your chances of retiring when you want to. Four in 10 Americans (44%) who borrowed from a retirement plan say they regret it, and another 23% don’t regret it but would not do it again, according to a recent TIAA-CREF survey.1

Still, borrowing from retirement plans is common: 29% of those surveyed said they have taken a loan from the savings in their workplace 401(k), 403(b) or defined benefit plan, with nearly half  of those (47%) borrowing more than 20% of their savings.

Is there a good reason to borrow from retirement savings?

Why do Americans take loans from their workplace retirement plans? Top reasons include:

It seems, though, that many people are taking loans for what they believe to be the wrong reasons. Although 46% of respondents borrowed from retirement savings to pay off debt, only 26% said that was a good reason to do so.

It can be difficult to deal with big-ticket items and especially with unexpected expenses. But are retirement plan loans the best option for these situations?

Downsides of retirement plan loans

The popular misconception that “you’re paying yourself back” when you repay a retirement plan loan overlooks the lost potential earnings during the payback period. For instance, a $10,000 loan paid back over five years could mean you are forgoing more than $3,500 in potential earnings.2  Also, many borrowers put less money into their retirement plan when they are paying back a loan: More than half (57%) of those who took a retirement loan cut their contribution rate while they paid back the loan.

Retirement plan loans, like many other types of loans, may charge some loan origination fees. Also, even though you are borrowing from your own account, you still must repay the loan, which comes with risks: If you leave your job and have money due on the loan, you may have to pay off the loan within 60 days, or declare the entire amount of the loan as a taxable distribution, depending on plan rules. Similarly, if you do not repay your workplace loan in a timely manner, you will be considered in default of the loan. Both scenarios can trigger tax payments and a 10% penalty on the entire amount borrowed.

Consider other sources of money

Every situation is different, and the best way to find out what’s right for you is to talk to your TIAA-CREF advisor. But there are a few scenarios that you might want to consider if you need to raise money today.

If the only option available to you is to tap your retirement funds, find out how loans are structured with your employer. Some TIAA-CREF plans allow you to continue earning interest while you are paying back the loan.

If you have exhausted your loan options, you may qualify for a hardship withdrawal, which the IRS allows for a few reasons—for example, to pay tuition or medical expenses, purchase or repair damage to a principal residence, or avoid foreclosure on a home. Note that employers are not required to allow hardship withdrawals or to grant them for all the IRS-approved reasons, so you would need to find out if your plan allows them.

This type of withdrawal requires that you demonstrate enough of a hardship to justify needing it, and that you show that you have no other resources available to address the need. Hardship withdrawals also come at a high cost: Once you receive the withdrawal, you’ll owe income tax on any pretax money you withdraw. If you’re under age 59 ½, you may also incur a 10% federal penalty for a premature distribution as well as a possible state penalty.

If you own a Roth IRA account, that can serve as another potential source of funds. Roth IRA contributions are made with after-tax money, allowing you to withdraw your original contributions at any age, free of federal taxes and penalties. If your Roth IRA has been open for at least five years, you can withdraw earnings free of federal taxes after age 59 ½, or up to $10,000 at any age to make a qualified first-home purchase.

Outside of retirement funds, you have a few options.

For higher education expenses, investigate scholarships or student loans. You can borrow to pay for college costs, but you can’t borrow to fund your retirement.

If you are a homeowner, home equity loans and home equity lines of credit can let you borrow against the value of your home. With a home equity loan, you receive a lump sum amount and pay the loan back over a predetermined period of time. With a line of credit, often known as a HELOC, you can access a specific amount of credit to tap on an as-needed basis. It is important to note, though, that you could lose your home if you do not repay the loan.

Where should you look for funds?

Each option has pros and cons, but there are a few avenues to consider if you need to raise money for a significant or unexpected expense:

If you have a permanent life insurance policy, that could be another source of funds. The premiums you pay toward a permanent life insurance policy build cash value in the policy, which you can access by making withdrawals or taking out a loan. Note that any loans or withdrawals will reduce your policy cash value and death benefit and may have tax consequences.

Finally, build an emergency fund to cope with unexpected expenses in the future. Generally, you should have enough to cover at least three to six months of living expenses in the event of an emergency such as a job loss. Other uses for a fund can include medical expenses and car repairs. If you have no money set aside for emergencies, aim to set aside $500 or so as a start and build from there.

Know your options

It can be difficult to deal with life’s many expenses and demands for your money while also safeguarding your financial future. Before you make any decisions, consult your TIAA-CREF advisor to learn how TIAA-CREF can help.

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