Despite the best financial advice, not everyone has a robust enough emergency fund to weather all possible unexpected events or even monthly expenses. It can be tempting to look at other money you have squirreled away, such as your 401(k) retirement account, when the need arises.
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Finding yourself in a financial bind is a good time to revisit and tighten your current budget, as a lot can be uncovered with a detailed review of your monthly expenses. Often, temporary adjustments can free up necessary funds without the need to compromise your retirement savings. However, sometimes there is no shaking off a financial shock, so ultimately, each scenario is unique.
While you can borrow money from your own 401(k), the question is, should you? Depending on your financial circumstances, that answer varies. When it comes to leveraging money from your retirement savings, here are several things to know about why you should or shouldn’t, as well as when and why you should consider it.
Only Consider It as a Last Resort
There are good reasons to borrow from a 401(k), but not many. Borrowing or making early withdrawals from a retirement plan should only be after you have run through all other options. If your 401(k) is tapped into too early, it can result in unwanted taxes and penalties down the road. In other words, lost money.
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Losing Your Job
One of the biggest risks with a 401(k) loan is getting laid off or leaving your job. Unexpected job loss is often a time when you are trying to scramble to make ends meet and keep the lights on by paying your utility bills.
However, if you do get laid off or fired, the loan immediately becomes a taxable withdrawal, and doesn’t factor in the interest you pay. No other loans will tie you to a specific job, which can limit your options for work over the term of the loan. Make sure to consider this when tempted to take from your vested account balance.
Keeping Your Credit Score High
The better your credit is, the more options you may have at your disposal in terms of debt products that could have low enough interest rates to satisfy your needs. A financial advisor might recommend utilizing a 0% interest rate credit card rather than borrowing from your 401(k). However, this is only the case if you can budget enough to pay off the debt before the 0% window closes.
Consider a HELOC
If you own a home, a home equity line of credit (HELOC) can also be a valuable emergency tool to help you cover expenses and bills when times get tough. With the housing market and economy at large remaining uncertain, home values are higher today than ever before, and many homeowners could be sitting on substantial assets. Leveraging this rather than your retirement savings and future financial security could be the savvier money move.
Borrowing Against Your Future
Don’t forget that tapping into your 401(k) early can significantly impact your retirement savings due to lost compound interest and potential penalties and taxes on the withdrawal. Always consider the long-term ramifications of such a decision.
Only Borrow If the Situation Demands It
The bottom line is that yes, you should try to avoid withdrawing from a 401(k) if you can help it. However, this isn’t a perfect world and stuff does have a tendency to happen. Here are some situations where you might consider borrowing from your 401(k) or another retirement plan, including the following:
- Upfront relocation expenses or travel expenses for a job where the expense may later be reimbursed by an employer
- Arrearages on mortgage payments; i.e., using money borrowed from a 401(k) to catch up on mortgage payments to prevent foreclosure
- Arrearages on car payments; i.e., using money borrowed from a 401(k) to catch up on car payments to prevent repossession
- Legal fees in situations including child custody, divorce, estate planning and traffic court
- Debt repayment for a loan from a friend or family member to maintain a good relationship
- Funding expenses that are likely to pay off in the future, e.g., education, home improvements and equipment needed for a side gig
- As a temporary “bridge loan” between expenses and income, e.g., to buy a new house before your previous house is sold.
Consider Alternative Ways To Pay
For those facing large, unexpected bills, it’s critical to have a comprehensive strategy rather than a single solution. Establish an emergency fund, yes, but also consider insurance policies, asset protection and even legal structures that can provide financial safety nets.
If workers decide not to borrow from their 401(k), some alternative sources of cash could be found in the following ways:
- Borrowing against a cash value life insurance policy
- Selling valuable possessions, e.g., electronics and jewelry
- Asking family members for financial assistance, either as a loan or a gift
- Applying for a low-interest personal loan from a bank or credit union
- Crowdfunding for cash using online platforms, such as GoFundMe
- Applying for benefits from government, religious and/or non-profit agencies, like SSI, SNAP, TANF, food pantries, housing assistance and utility assistance
- Contacting employee assistance programs at work to inquire about pay advances and other financial support
- Starting a side hustle to generate additional income.
Jordan Rosenfeld contributed to the reporting of this article.
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This article originally appeared on GOBankingRates.com: 7 Things To Know About Borrowing From Your 401(k) To Pay Bills
