Consider Taking a 401(k) Loan to Get You Through the COVID-19 Crisis

• Author: Michael Bordonada
• Posted: 2024-06-25

Many Americans have been beset by personal financial hardships during the economic dislocation caused by the COVID-19 crisis. Many may be considering tapping into their retirement accounts and borrowing from them to help them through unemployment and other economic consequences caused by a slowdown in business or job loss. While this may be a readily available source of funding, it still is a debt, even if you owe it to yourself. Here are some considerations to think of if you are entertaining the possibility of taking a 401(k) loan to help get you through the coronavirus crisis.

Make Sure to Consider Alternatives First Because There Is a Cost to Retirement Loans

The first thing to think about is whether there are any alternatives to borrowing against retirement. Your 401(k) is invested in the market right now, and if you take out a loan against it, you will be liquidating your holdings that have already declined. Thus, you will lose the ability to participate in the gains should the market rebound when the threat posed by the virus recedes. The other pitfall is that you are not able to contribute to your retirement when you have an outstanding loan. However, given the fact that your need for a loan arises from financial distress, you may not have that money to contribute anyway. Unfortunately, you will be missing out on matching employer contributions during this time. This is not to say that borrowing against your retirement is a bad thing. It just may be an option to explore after you have considered alternatives given the fact that a 401(k) loan is not without its detriments.

You will want to look at other available sources of funding that may be available to you. Interest rates are extremely low right now as the Federal Reserve Bank has slashed the target rate to zero and banks have followed by cutting their own rates. You could obtain a second mortgage on your home at very low rates which could give you the money that you need to get through this crisis. The options that are available to you depend on your credit. If you are able to get a low rate, this may be your best bet. However, some loans are available at much higher rates that simply do not make them worth it.

The next thing to think about is whether you will actually be able to pay the loan back. If you default on a loan taken against your 401(k), it is treated as a distribution and you must then incur the penalties that you would under those circumstances. This includes paying taxes on the amount that you have borrowed as well as a ten percent penalty for early withdrawal. Then, your creditor becomes the IRS, and Uncle Sam can be a little more difficult to deal with when the government is owed money.

The Benefits of a 401(k) Loan

This is not to say that it is a bad thing to take a loan against your 401(k) account. Recent laws have been changed to make it easier for borrowers to do just that. If you are dealing with a small amount of money that you will be able to pay back when things have returned to normal, your retirement account is actually a cheap source of capital that does not involve going to a creditor.

Even better, the interest that you pay when you take out a 401(k) loan goes to yourself. This means that you are not giving your money to a lender. Instead, you are merely shifting it from your checking account to your retirement account. Of course, you cannot take that money out as a distribution when you have recovered financially without incurring penalties. Nevertheless, a 401(k) loan comes at no cost to you so long as you are able to repay it.

Not all employers offer the ability for their employees to take a loan from their 401(k). The new law makes it easier for companies to implement loan programs with little effort, so you should press your employer to offer this program if they do not already. Many employees put money away for retirement each month and forget that this money may be there for them in advance of retirement if they run into a jam and need to access it.