A recent article on the Fox Business Web Site made some excellent points about whether it is a good idea to borrow against your pension. I have generally advised my New Jersey clients not to use pension loans to pay debt, but this article is helpful in deciding whether a loan like this is a good idea.
What to Consider in Deciding to Borrow
The general thinking is borrowing from your 401(k) should only be an option if you’re unable to get a loan elsewhere and can pay the loan back within a reasonable amount of time. Ask yourself these questions if you are thinking about a pension loan:
- What are the loan terms? Is the rate and repayment term "do-able"?
- What happens if you can't pay it back? Even though you are borrowing from yourself (and paying yourself interest), there is a serious consequence to breach: taxes! The unpaid balance becomes ordinary income and can force you into a higher tax bracket. There is also a 10% penalty if you are under 59.5.
- Do you have job security? If you leave your job for any reason (quit, fired, or laid off) the balance falls due in a lump sum within 30-60 days. If you are on shaky ground, you might not want to consider this.
- Where will your money earn more? Will your money earn more at the rate of return in the retirement fund or at the interest rate you are paying yourself? Remember, this is your future!
- Why are you borrowing the money? If you need it for a short term cash flow fix, it's a bad idea! The same is true for something frivolous, like a vacation or a car. You should do it only for financial emergencies or a stopgap, where you know you will be able to pay the money back quickly.
When You Should Borrow Against Your Pension
It's not like there is never a good reason to borrow against your 401(k). The article suggests two instances where you should:
- To Buy a House. Using the funds for a downpayment on a home might help you get a better rate on a mortgage. Even then, you should be prepared to pay it back within 6 to 9 months, despite the fact that that the loan can be repaid in up to 15 years.
- If you can repay the loan and still contribute to the pension. Again, this money constitutes your future. Assuming the rate of interest you are paying yourself is higher than the rate of return of the fund, you can't afford to lose continued contributions of principal over the loan period.
If, after considering all of this, you find yourself borrowing money to pay down debt that grew because you are spending beyond your means, and you live in the Gloucester County New Jersey area, give me a call at 856-432-4113 or contact me through this site to discuss bankruptcy as an option. You are in a vicious cycle that will only dig you in deeper. You deserve a fresh start!