Should you borrow from your 401(k)?

When you need money to pay for a large expense — like a medical bill, your child’s education or a wedding — borrowing from your 401(k) may seem like an easy, convenient way to access the funds you need. But before you withdraw money from your retirement nest egg, consider the pros and cons to determine if it’s the best borrowing option for you.

What you need to know about 401(k) loans

For starters, not every 401(k) plan lets you borrow funds from your account, and some plans may only allow borrowing for specific purposes. Be sure to review your 401(k) plan documents carefully or contact your employer’s human resources department if you’re unsure.

In most cases, 401(k) loan rules let you borrow 50% of your vested balance, up to $50,000. You’ll begin making payments on the loan right away, and the loan must be paid in full within five years. Loan payments are usually made through monthly automatic deductions from your paycheck. Keep in mind that if you leave your company for any reason before the loan is paid in full, you’ll need to repay the loan within 60 days.

A 401(k) loan may be a smart way to access the funds you need, especially if you feel confident that you can repay the loan quickly and continue making contributions toward your retirement. However, consider the following advantages and potential challenges before you make a decision.

Pros

• The loan process is quick and easy with minimal paperwork compared to other types of loans
• The loan process doesn’t involve a credit check
• The interest you pay goes back into your retirement fund
• It may be a smart option if your only borrowing alternative is a high-interest credit card

Cons

• A 401(k) loan reduces the total amount you could have invested into your retirement fund
• You’ll lose out on compound interest you would have accrued in your retirement account
• You’ll pay additional fees if the loan is not repaid on time

Other borrowing options to consider

Before tapping your nest egg to cover a large expense, be sure to consider other borrowing alternatives that don’t put your retirement savings at risk. For instance, a home equity loan or home equity line of credit (HELOC) may provide a convenient alternative. Home equity borrowing offers flexible payment options and lower interest rates than other types of borrowing, and often does not require closing costs. You may also want to consider tapping into an emergency savings account or taking out a personal loan, which may be easier to repay than a 401(k) loan.

If you have a big expense, whether planned or unplanned, it helps to understand your borrowing and repayment options so you can make the best decision for your needs, while keeping your long-term financial goals on track. To learn more about financing solutions available to you, visit our website or contact us at your local Commerce Bank branch.

Also see:

• What to know about using a home equity line of credit
• Six questions to ask to find the right financial advisor