As parents around the country prepare to send their children off to college this fall -- and face the added financial pressure of tuition bills -- some may be thinking about borrowing from a 401(k) to help make ends meet. Our research actually shows that more people borrow from their 401(k) during the summer than at any other time of year.*
While borrowing from your 401(k) may seem like a quick cash fix, it's almost never a good idea. Here's why:
- If you leave your job for any reason, you'll need to pay back that loan ASAP, sometimes within as little as 30 days after you leave your employer or are otherwise separated from service. If you can't pay it in full, you'll owe taxes on the balance, and probably an additional 10 percent penalty if you're under age 59½. These penalties and taxes can make a bad situation even worse.
- You might also be cheating your future self. While they're paying back a 401(k) loan, we find that many people stop saving in their 401(k) plan. This is a huge mistake and can really de-rail your retirement savings. Plus, that money you borrowed is no longer invested for your retirement, missing the potential for market growth. A 401(k) is about the future, not the present.
- Even though you're borrowing from yourself, you still have to pay that loan back with interest. And you have to pay it back with after-tax money, which then gets taxed again when you withdraw it at retirement. These after-tax loan repayments defeat one of the main benefits of a 401(k)-- pre-tax savings.
- Finally, keep in mind that money in a 401(k) plan is generally safe from your creditors. Once it's out of the plan, it's fair game.
You want to help pay for your child's education. But remember -- while your child may be able to get a loan for college, you can't get a loan for retirement. Borrowing from a 401(k) should always be your last resort -- only when all other options have been exhausted and the loan is part of your long-term plan. A loan should never be a quick fix. That short-term gain can easily lead to long-term pain.
*Schwab Retirement Plan Services, Inc./Schwab Retirement Plan Services Company data - 2005-2011.
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