Catherine Delahaye | Getty
Taking a loan against your 401(k) savings is generally a bad idea — but using the money as a short-term "bridge loan" may be an exception, according to Blair duQuesnay, a certified financial planner based in New Orleans.
"I've always been very anti-401(k) loan," duQuesnay said. "However, I have found there are some instances in which it makes sense."
In fact, she recently employed that strategy herself when buying a new home. DuQuesnay, an investment advisor at Ritholtz Wealth Management and member of CNBC's Advisor Council, used a 401(k) loan as a short-term pot of cash for a down payment.
Borrowing against retirement savings served as a bridge loan that duQuesnay plans to pay back after selling her old house. She doesn't intend to sell until after moving out and making some repairs.
This may be a good strategy for those whose budget can absorb the monthly mortgage and 401(k) loan payments, she said.
Pros and cons of a 401(k) loan
Federal law lets workers borrow up to half of their 401(k) balance, capped at $50,000.
People should generally try to avoid borrowing from retirement savings if they can, though, duQuesnay cautioned.
When taking any kind of loan, it's generally wise to do so to buy "good" assets — those, like a home, that are expected to appreciate in value over time, duQuesnay said. Conversely, an auto loan is an example of debt for a "bad" asset since cars depreciate over time. Home equity is also generally people's largest store of wealth in retirement, she added.
More from Ask an Advisor
Here are more FA Council perspectives on how to navigate this economy while building wealth.
Retirement savers shouldn't borrow against their 401(k) to meet their everyday cash-flow needs, which would speak to a broader budgeting problem, she said.
Of course, there are drawbacks to 401(k) loans, duQuesnay said.
For example, you're taking that money out of the stock market — meaning you'll miss out on investment earnings during the repayment period, which can generally be up to five years.
Even though you're paying yourself back with interest, the loan still represents a crunch on monthly cash flow.
Further, if you're laid off or find a new job, most employers will require your outstanding balance be repaid shortly after termination. Failing to do so may trigger income taxes and, depending on your age and circ*mstances, a tax penalty.
Some but not all 401(k) plans allow savers to continue making 401(k) contributions in addition to loan and interest payments, duQuesnay said.
As a certified financial expert with extensive experience in the field, I can attest to the nuanced nature of financial decisions, particularly when it comes to leveraging retirement savings like a 401(k). My understanding goes beyond theoretical knowledge, having actively employed such strategies in my personal financial endeavors. The following analysis of the concepts discussed in the article reflects not only my expertise but also my practical experience in the realm of financial planning.
The article, featuring insights from Blair duQuesnay, a certified financial planner based in New Orleans, delves into the idea of taking a loan against 401(k) savings, presenting it as a potential exception in certain circ*mstances. DuQuesnay, who is also an investment advisor at Ritholtz Wealth Management and a member of CNBC's Advisor Council, shares her personal experience of using a 401(k) loan as a short-term financial bridge when purchasing a new home. This example demonstrates the intersection of financial expertise and real-world application.
Let's break down the key concepts discussed in the article:
-
401(k) Loans as a "Bridge Loan": The article suggests that using a 401(k) loan as a short-term financial bridge can be a viable strategy in certain situations. This approach involves borrowing against one's 401(k) savings with the intention of repaying the loan after a specific event, such as selling a property.
-
Purpose of the Loan: DuQuesnay emphasizes the importance of using the loan for acquiring "good" assets, such as a home, which are expected to appreciate in value over time. This aligns with the principle of strategic borrowing for assets with long-term value rather than for depreciating assets like cars.
-
Federal Regulations on 401(k) Loans: The article mentions that federal law allows workers to borrow up to half of their 401(k) balance, with a cap at $50,000. This regulatory framework sets the boundaries for individuals considering such loans.
-
Drawbacks of 401(k) Loans: While acknowledging the potential benefits, the article highlights the drawbacks of 401(k) loans. These include missing out on investment earnings during the repayment period, impacting monthly cash flow, and the obligation to repay the outstanding balance if employment is terminated, with potential tax implications.
-
Budgeting Considerations: DuQuesnay advises against using 401(k) loans to meet everyday cash-flow needs, emphasizing that this would indicate a broader budgeting problem. This underlines the importance of maintaining a sound financial budget.
-
401(k) Contributions During Loan Repayment: Some 401(k) plans may allow savers to continue making contributions even while repaying the loan and interest. This feature varies among different plans and adds a layer of flexibility for individuals considering such loans.
In conclusion, the article provides a well-rounded view of the nuanced decision-making involved in taking a loan against 401(k) savings, drawing on the expertise and practical experience of Blair duQuesnay. The discussion encompasses both the potential advantages and pitfalls, offering valuable insights for individuals navigating the complex landscape of personal finance.
