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Retirement Plans a Gold Mine, But Not for Satisfying Debt

Practice Management

The mail came! There’s a statement showing growth in the retirement account. There’s another showing that a debt that accumulated isn’t getting any better. Tempting… but a recent blog entry argues that using some retirement plan funds to satisfy a debt is a siren song.

In “Why Borrowing from a Retirement Plan to Pay off Debt Is a Bad Idea,” an entry in Cammack Retirement’s “Top of Mind” blog, Michael Webb explains why borrowing from a 401(k) or 403(b) “appears to be a savvy financial move,” but offers suggestions regarding why it may not be.

Borrowing more money to pay the debt does not address how and why it started. Debt is probably the result of many factors, Webb argues, which “don’t go away when you borrow even more.” He cautions that “the world is littered with people who took out 401(k)/403(b) loans” but are still indebted.

Some plans have tough repayment rules for those changing jobs. Most 401(k) plans (and some 403(b) plans) do not allow one to continue repaying a loan if one leaves a job through which the account was opened, offset the outstanding loan balance against the funds in one’s retirement account.

Taking a loan means sacrificing retirement income. “The earlier in your working career you borrow, the greater the impact due to the time-value of money,” writes Webb. This, he says, is because the principal taken early affects retirement income; in addition, the interest paid back to the account is less than what would have been earned on the amount taken out in the loan. Not only that, the interest is paid back after taxes are imposed, and taxes are imposed again when it ultimately is withdrawn from the account.

Webb suggests that individuals consider exploring alternatives to plan loans, and that plan sponsors offer benefits to employees that will help them to handle loans and manage their finances and debt.