Many of us are cash-strapped. We might need money for a down payment on a house, to pay off our credit card debt, or even to hold us over when we are unexpectedly left without employment.
For most of us, savings are in short supply. However, many people have savings in the form of a retirement account, which is unavailable. Or is it? Rather than liquidating a retirement account when cash is in short supply, many people are considering whether they should simply borrow against it.
When you close a retirement account, you have to pay taxes and fees to cash it in before the appropriate time. Money drawn out of a retirement account will cost you between 25 and 50 percent, depending on your tax bracket and the applicable fees. However, it might be possible to take a loan against your retirement account to pay that debt, make a down payment or take advantage of that big opportunity without those additional costs.
First, check your retirement account for details. Does it allow loans? You are not allowed to borrow against Individual Retirement Accounts —IRAs and Roth IRAs. You may be allowed to borrow against a 401(k), 403(b) or 457(b).
Some retirement accounts offer a hardship distribution in certain cases, such as down payment or repairs to a home or saving a home from foreclosure. Be sure to check your account then check the IRS website for regulations on a hardship distribution. That may solve your cash shortage, but remember that you are liquidating your savings and any future gains from that account.
A loan on your retirement account, however, may be a good option for you. Accounts that offer loans cap the amount that can be borrowed at 50 percent of the total amount in the account. In addition, the Internal Revenue Service sets a maximum amount of $50,000 for a loan, regardless of how much money is in the account.
Remember that this is a loan, so it must be repaid. Get clear on the terms of that loan. Most loans have a five-year term, but could be longer if you are borrowing for a down payment on your primary home. The interest rate should be approximately what the going rate is if you borrowed the money. In most cases, the loan can be repaid with a payment or a deduction from your paycheck. Just make sure you understand exactly how the loan will be repaid.
Like all financial transactions, there are good and bad aspects of this action. The good aspect is that you are paying it back to yourself and the interest paid goes into your account. If you have marginal credit, you probably can get a better interest rate and terms than from a conventional lender. The bad aspect is that you are raiding your retirement funds and it will take a long time for your funds to reach prior levels. If you leave that employer, the loan must be paid in 90 days. If you fail to repay that loan, there are tax penalties and fees.
Borrowing against your retirement may make sense for your financial future, but before you take that step, check the details on your account and the rules and policies at www.irs.com.
Roxie Rodgers Dinstel is associate director of the Cooperative Extension Service, a part of the University of Alaska Fairbanks, working in cooperation with the U.S. Department of Agriculture. Questions or column requests can be e-mailed to her at firstname.lastname@example.org or by calling (907)474-7201.