Disadvantages of a Retirement Plan Loan

Borrowing money from your retirement plan loan has several disadvantages. Before you make the choice to loan yourself money from your retirement benefits, you should be aware of the potential drawbacks.  

Interest Paid Is Less

Interest that is paid on your retirement plan loan is often less than the rate the plan would have earned otherwise.

Smaller Contributions

Since you now have a retirement plan loan to pay back, you may find yourself scaling back your contributions to your retirement account, thus reducing your retirement account balance.

Loan Defaults are Costly

Should you leave your employer, you'll have to pay back your loan immediately. Some retirement plan loan rules stipulate repayment within 60 days of employment termination. If you still don't pay, it is considered in default, you will have to pay taxes on the outstanding balance, including an early withdrawal penalty if you are not 59-1/2 years old.

Interest Is Not Tax-Deductible

Any interest you pay is not tax-deductible, even if you use the loan to purchase a home.

Fees, No Loan Terms Flexibility

There may also be fees involved. And you have no flexibility with respect to the changing the payment terms of your retirement plan loan.

Reasons Not To Take Out a Retirement Plan Loan

There are numerous reasons why a retirement plan loan may not be in your best interests. These include:

  •  You are be nearing retirement.
  •  You might lose your job due to cutbacks, restructuring or termination.
  •  You are considering changing jobs in the near future.
  •  You need the funds for everyday living expenses.
  •  You won't be able to repay the loan right away if you're let go or leave your employer.
  •  You want the money for a vacation or a luxury item you don't really need.
  •  You aren't able to continue to make regular contributions to your plan.

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