Editors' pick: Originally published Sept. 15.
There is a lot riding on your 401(k) these days.
For many, the employer-sponsored account is the only retirement savings they have, and thus, along with Social Security, will produce the only income they will have in retirement.
Gone are the days when companies send out monthly pension checks and provide benefits to retirees, such as health insurance. Today, your retirement is essentially do-it-yourself, which, in effect means that if you screw it up you will likely end up living on Social Security. And the monthly Social Security check averages only $1,341 in this year.
So the goal, especially for those approaching retirement, should be to save as much as you can as fast as you can in your 401(k) and let it grow as long as you can.
But complicating that is the fact that many companies also allow you to borrow from your 401(k). That can be a necessary tactic in a real emergency. But that doesn't mean it's a good strategy.
According to Fidelity, 11% of Americans took out 401(k) loans last year, and the average loan was $9,500.
The problem, says Fidelity, is for most people, a loan has a lasting impact on their retirement savings, even though they are paying themselves back with interest. One reason: 40% of the people who take out a 401(k) loan also reduce the amount of their contributions. A full 9% stopped making contributions altogether, Fidelity says.
"I'm against it," says financial planner Nick Abrams at AJW Financial Partners in Columbia, Md. "When you start borrowing form the plan, there are a lot of catches people don't understand. If you decide to leave the company, some companies demand payment in 60 to 90 days, and if you don't, the money becomes taxable."
"You are borrowing against assets," he adds. "Even though you are paying yourself back with interest, it's not earning interest. You are losing borrowing power. We generally try to discourage it for our clients."
Bill Van Sant, senior vice president at Girard Partners, says many people today are already unprepared for retirement.
"I hate impacting one's retirement savings, especially with today's statics," he says. "Many people have a projected retirement shortfall. Borrowing is a dangerous."
Abrams says he does have clients who have borrowed from their retirement savings.
"Some of them do," he says. "We try to sit down and look at other options. We want to make that a last resort, where they have exhausted all other options and have no other choice but to borrow form 401(k). It has to be a dire emergency."
Generally, he tries to recommend against this measure.
"We've seen cases where people will leave a job and don't realize they've got to pay that money back," he says. "Some (employers) will give you a coupon booklet (for loan payments). We have had incidents where the book didn't come, they didn't pay on time and loan went into default. Then you get that 1099 for the outstanding balance."
Van Sant says, however, that there may be times when it may not be a bad idea to take out a 401(k) loan.
"It may be preferred route when it comes to securing a mortgage," he says. "With mortgage rates in the high threes, a person may be in position where they can afford it, but may not have the dollar amount to put down. If they have amassed some savings, they can get a quick $50,000 easily, with no long application to secure that fixed 30-year rate."
"That would be a good opportunity to do it," Van Sant adds. "They know they have locked in a historically lower rate."
Other than that, Van Sant says he's looks someone's 401(k) like the Federal Reserve, the lender of last resort.
"Clients should exhaust other methods first," he says. "It creates this well you can constantly go back and drink from. That impacts one's retirement."
Abrams, meanwhile, says that even though not all of his clients listen to his advice on the loans, they do discuss it with him before they act. And that's a good thing. "Most clients will come to me before they do it," Abrams says. "They will ask. I appreciate them coming to me beforehand."