NEW YORK -- For some people in need of quick cash, a 401(k) retirement account can look pretty tempting. It's often their biggest pot of savings, and most company plans are set up so participants can borrow from them in emergencies.
Experts caution, however, that tapping these accounts carries risks, not only in reducing the total savings available for retirement but also in triggering taxes and penalties if the loan isn't paid back.
"Borrowing from a 401(k) or other retirement savings account is a terrible thing to do," said Dallas L. Salisbury, head of the Employee Benefit Research Institute in Washington. "It should be a last resort -- if you really, really need to borrow money and that's the only place you can do it."
Still, surveys by the nonprofit group indicate that about one-fifth of participants in plans that allow borrowing do take out loans. The limit is 50 percent of the account's balance, or $50,000, whichever is lower. The average outstanding loan is about $6,800, the surveys show.
People do, of course, face emergencies that require quick access to cash.
They often look to their 401(k) accounts, or the 403(b) accounts for workers in nonprofit industries, because it's easier to tap them than it is to take out a personal loan or qualify for a home-equity loan. Anyway, the argument goes, you're essentially borrowing from yourself and repaying the money with interest, generally a point or two above the prime lending rate.
But that ignores the long-term costs.
Nationwide Financial, a Columbus, Ohio, company that administers retirement plans, provides these calculations: A 35-year-old worker who usually makes $2,000 a year in contributions to his 401(k) plan takes out a $10,000 loan. If, over the five-year repayment period, he discontinues his annual contributions, he will have $134,950 less at age 65 than if he had continued his regular savings. Even if he continues his contributions during the repayment period, his account will be reduced by more than $9,000.
Judy Miller, a financial planner who heads the College Solutions advisory service in Alameda, Calif., says that would-be borrowers "shouldn't forget that they forgo what they would have earned on that money had it been invested," most likely at a higher rate than the loan is pegged at.
In addition, "you're essentially a prisoner of your employer" because the loan is due in full if you leave your job or lose your job, she said. If you can't repay the balance, the IRS considers it a "distribution" that is subject to federal taxes, a 10 percent penalty and state taxes.
Brainerd Dispatch ©2013. All Rights Reserved.