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Taking a loan against your 401(k) savings is generally a bad idea — but using the money as a short-term “bridge loan” may be an exception, according to Blair duQuesnay, a certified financial planner based in New Orleans.
“I’ve always been very anti-401(k) loan,” duQuesnay said. “However, I have found there are some instances in which it makes sense.”
In fact, she recently employed that strategy herself when buying a new home. DuQuesnay, an investment advisor at Ritholtz Wealth Management and member of CNBC’s Advisor Council, used a 401(k) loan as a short-term pot of cash for a down payment.
Borrowing against retirement savings served as a bridge loan that duQuesnay plans to pay back after selling her old house. She doesn’t intend to sell until after moving out and making some repairs.
This may be a good strategy for those whose budget can absorb the monthly mortgage and 401(k) loan payments, she said.
Pros and cons of a 401(k) loan
Federal law lets workers borrow up to half of their 401(k) balance, capped at $50,000.
People should generally try to avoid borrowing from retirement savings if they can avoid it, though, duQuesnay cautioned.
When taking any kind of loan, it’s generally wise to do so to buy “good” assets — those, like a home, that are expected to appreciate in value over time, duQuesnay said. Conversely, an auto loan is an example of debt for a “bad” asset since cars depreciate over time. Home equity is also generally people’s largest store of wealth in retirement, she added.
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Retirement savers shouldn’t borrow against their 401(k) to meet their everyday cash-flow needs, which would speak to a broader budgeting problem, she said.
Of course, there are drawbacks to 401(k) loans, duQuesnay said.
For example, you’re taking that money out of the stock market — meaning you’ll miss out on investment earnings during the repayment period, which can generally be up to five years.
Even though you’re paying yourself back with interest, the loan still represents a crunch on monthly cash flow.
Further, if you’re laid off or find a new job, most employers will require your outstanding balance be repaid shortly after termination. Failing to do so may trigger income taxes and, depending on your age and circumstances, a tax penalty.
Some but not all 401(k) plans allow savers to continue making 401(k) contributions in addition to loan and interest payments, duQuesnay said.