Yahoo Finance Experts Explain: Should You Ever Borrow From Your 401(k) To Pay Bills?
Despite the best financial advice, not everyone has a robust enough emergency fund to truly weather all possible emergencies. It can be tempting to look at other money you have squirreled away, such as that tucked into a 401(k) retirement plan, when the need arises.
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While you can borrow from your own 401(k), the question is, should you? Depending on your financial circumstances, that answer varies.
Experts explain if you should or shouldn’t, when and why.
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As a Last Resort
There are good reasons to borrow from a 401(k), but there aren’t many, according to Stephen Kates, CFP, principal financial analyst for Annuity.org and a former wealth management advisor.
“Borrowing or withdrawing from a retirement plan should be nearly a last resort, after other, better options have been exhausted. In my experience, the 401(k) is tapped too early by most people who use it for this purpose.”
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The Risks
One of the biggest risks with a 401(k) loan is getting laid off or leaving your job, Kates explained. “If this happens, the loan immediately becomes a taxable withdrawal. No other loans will tie you to a specific job, which can limit your options for work over the term of the loan. Plan carefully and consider the value of flexibility.”
Keep Your Credit Score High
Additionally, the better your credit is, the more options you may have at your disposal, in terms of debt products that could have low enough interest rates to satisfy your needs, Kate said.
“For instance, utilizing a 0% interest rate credit card may be a solution, if you can budget enough to pay off the debt before the 0% window closes.”
Consider a HELOC
For those who own a home, a home equity line of credit (HELOC) can also be a valuable emergency tool for emergencies, Kates suggested. “With home values higher today than ever before, many homeowners are sitting on substantial assets in their home.”
Don’t Borrow Against Your Future
Don’t forget that tapping into your 401(k) early can significantly impact your retirement savings due to lost compound interest and potential penalties and taxes on the withdrawal, according to Marty Burbank, owner of OC Elder Law.
“It’s imperative to consider the long-term ramifications of such a decision. Instead of borrowing against your future, exploring alternatives, like asset protection strategies…” he said.
Situations When You Might Borrow
Barbara O’Neill, Ph.D., CFP, an expert contributor and reviewer for Annuity.org and author of “Flipping A Switch: Your Guide to Happiness and Financial Security in Later Life,” also leans toward not withdrawing from a 401(k) if you can help it.
However, she said, “In the real world, stuff happens.”
She laid out some situations where someone might consider borrowing from their 401(k) or other qualified retirement plan, including the following:
Upfront relocation expenses or travel expenses for a job where the expense may later be reimbursed by an employer
Arrearages on mortgage payments; i.e., using money borrowed from a 401(k) to catch up on mortgage payments to prevent foreclosure
Arrearages on car payments; i.e., using money borrowed from a 401(k) to catch up on car payments to prevent repossession
Legal fees in situations including child custody, divorce, estate planning and traffic court
Debt repayment for a loan from a friend or family member to maintain a good relationship
Funding expenses that are likely to pay off in the future; e.g., education, home improvements and equipment needed for a side hustle
As a temporary “bridge loan” between expenses and income; e.g., to buy a new house before your previous house is sold.
Consider Alternative Ways To Pay
For those facing large, unexpected bills, it’s critical to have a comprehensive strategy rather than a single solution, Burbank urged. “Establish an emergency fund, yes, but also consider insurance policies, asset protection and even legal structures that can provide financial safety nets.”
If workers decide not to borrow from their 401(k), some alternative sources of cash — if they do not have an adequate emergency fund — include the following, O’Neill explained:
Borrowing against a cash value life insurance policy
Selling valuable possessions; e.g., electronics and jewelry
Asking family members for financial assistance as either a loan or a gift
Applying for a low-interest personal loan from a bank or credit union
Crowdfunding for cash using online platforms, such as GoFundMe
Applying for benefits from government, religious and/or non-profit agencies, like SSI, SNAP, TANF, food pantries, housing assistance and utility assistance
Contacting employee assistance programs at work to inquire about pay advances and other financial support
Starting a side hustle to generate additional income by freelancing.
Tighten Your Budget
Lastly, finding yourself in a financial bind is a good time to revisit and tighten your current budget, according to David Blain, CFA and CEO of BlueSky Wealth Advisors. “It’s remarkable what can be uncovered with a detailed review of your monthly expenses. Often, temporary adjustments can free up necessary funds without the need to compromise your retirement savings.”
Ultimately, each individual scenario is unique, but consider as many other options as you can before borrowing from your 401(k).
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This article originally appeared on GOBankingRates.com: Experts Explain: Should You Ever Borrow From Your 401(k) To Pay Bills?
