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Short-Term Borrowing from a 401(k): Are There Alternatives?

Financially stress woman

Employees who are fortunate enough to work for a company that provides a defined-contribution plan like a 401(k) hopefully maximize that opportunity and receive employer matching funds to boot. With many Americans today living longer into their post-retirement years, we need all the retirement savings we can get. 

According to research from Charles Schwab, 72% of Americans who are within five years of retirement worry they will run out of money during their post-work years. And it takes money to truly enjoy your time off – staying healthy, keeping up your home, taking trips and being able to afford both necessities and the occasional luxuries. There is some encouraging news for younger workers; according to Principal’s 2019 Driving Plan Health report, Millennials have increased their total contribution rate in their 401(k) by 23% over the last six years and lead the way among the generations in proper account diversification. 

Sometimes employees withdraw from their 401(k), such as for a down-payment on a home. But often they are borrowing to cover unexpected expenses. And this year, of course, there are withdrawals due to income loss from the corona pandemic. In fact, The Harris Poll COVID-19 Tracker fielded May 8-10, 2020 found that nearly a quarter (22%) of Americans had dipped into their retirement savings because of COVID-19, especially those with an annual household income of $75,000+ (26%). 

Prior to the pandemic, employees were withdrawing in similar numbers from their 401(k)s. Results of a survey conducted by The Harris Poll on behalf of Purchasing Power® in December 2019 among 807 U.S. adults who are employed full-time reveals that 21% of those with a 401(k) had borrowed from it in the last 12 months. 

And it’s interesting to see the salary ranges for those who borrowed from their 401(k):
•    less than $50,000 – 11%
•    $50,000 - $74,999 – 17%
•    $75,000 - $99,999 – 29%
•    $100,000 – 25%

The survey identified the reasons those who borrowed from their 401(k) gave, including vehicle repair/replacement (41%); funeral travel or an unexpected move (36%); replacing or upgrading a major home appliance that stopped working (33%); medical costs like a sudden illness (31%); home repairs (31%); education expenses (28%); and down payment on a home (18%).  

Employees who turn to borrowing from their 401k to meet short-term needs will not have as great an opportunity to build wealth for their later years. They will have to repay the loan with after-tax dollars, plus they lose the investment earnings on the money while it’s out of the account. If they fail to repay the loan, the amount owed converts to a withdrawal, and tax and penalties will be due. Granted, life happens and unexpected expenses arise. Even a pandemic appeared this year. However, employees need a lifeline for these bumps in the road that doesn’t involve borrowing from their retirement future. 

Likewise, they need to avoid other methods of handling a gap in income that could have serious long-term ramifications, such as high-interest credit cards and payday, auto or other short-term loans that can carry interest rates upwards of 600% and easily sink borrowers into an inescapable debt cycle, wreaking havoc on their credit score. 

As an alternative, employees should try to take advantage of any voluntary benefits that are available to them through their employer. Often, employees aren’t aware some of these exist. These benefits may include low interest installment loans and credit as well as employee purchase programs that allow workers to purchase consumer products and services through payroll deduction. 

These alternatives to borrowing from a 401(k) can really make a difference when it comes to surviving and thriving in the retirement years. Let’s continue to look for ways to help keep short-term financial stress from derailing long-term investment strategies