The pros and cons of borrowing from yourself

Nearly a third of Americans have at some point borrowed from their retirement plan at work, according to a recent TIAA-CREF survey.  

Call me a skeptic, but from my experience that number seems low. And when it comes to this topic, that’s not necessarily a good thing.      

If you need cash, borrowing from your plan at work may seem tempting. After all, most offer loans of half your account value or $50,000, whichever is the lesser amount.  

But before you jump online to fill out an application, let’s explore the pros and cons.

The pros

  • It’s easy. Typically, you fill out a form and have the money in a few days. There’s no credit check or drawn-out application process. You usually make payments via payroll deduction.
  • It’s competitive. The interest rate is often low, especially compared to a credit card. For example, a typical rate might be the prime rate plus 1 percent –  today that’s 4.25 percent.
  • The interest goes to you. You keep the interest you pay, not some other lender.
  • Its use isn’t restricted. Simply put, you can use it for anything.
  • It has a definitive end. Most plans allow you to set up your repayment schedule from one to five years (perhaps longer in some situations).

The cons

  • It could reduce what you’re saving. This may be the scariest aspect of borrowing from a work retirement plan. Some plans forbid contributions while the loan is being paid back. What’s more, approximately 60 percent of recipients voluntarily reduce or eliminate their contributions during payback, according to the TIAA-CREF survey. Bad idea.
  • The bull could pass you by. If the markets go up, you could miss out on the growth your loaned money might have earned.
  • The bear may lurk around the corner.  If the markets head south, that low interest rate you’re paying yourself may not look all that bad.
  • Job loss requires payback. In most situations, you’re required to pay back the loan within 60 days if you leave the employer. If you’re unable, the outstanding balance could be subject to taxes and early-withdrawal penalties.
  • It’s habit-forming. According to TIAA-CREF, nearly half of those who take out loans will do so multiple times.  
  • It doesn’t fix the core issue. A whopping 46 percent of survey respondents took a loan to pay off other debts. If you haven’t fixed the reasons you have the debt in the first place, you may end up with a loan and a bunch of new debt you accumulate after “consolidation.”

In the end, it’s your call. An employer plan may be a practical and economic place to access money. However, in the midst of the current U.S. retirement crisis, it’s important not to overlook the potential negatives.

Tread carefully, and don’t lose your retirement savings momentum. 

J.J. Montanaro is a certified financial planner with USAA, The American Legion’s preferred provider of financial services. Submit questions for him online.