401(k) Loans Put Nest Egg on the Line

Financially strapped families are increasingly borrowing from their 401(k) and similar retirement plans to make ends meet. But, while the loans may offer low interest rates and a quick solution to immediate money troubles, they may not be the great deal they appear to be.

First, workers who borrow from their 401(k) accounts have to repay the loans through after-tax payroll deductions. That means that someone in the 28% tax bracket would have to earn more than $700 to clear enough, after taxes, to make a $500 loan payment. And the interest borrowers pay isn't tax-deductible, the way it is on a home equity loan or mortgage.

There also is the issue of lost growth potential while the retirement money is not invested.

And, perhaps the biggest blow to borrowers' future financial security, say experts, is any reduction or suspension of retirement plan contributions while the loan is being repaid. That is a particularly big cost if the employer offers matching dollars on employee contributions.

Experts encourage financially strapped workers to consider other options before cracking open their nest eggs: Try to negotiate a payment plan with service providers. Cut expenses and increase income as much as possible. Perhaps look to family members, friends, local nonprofits and other possible sources of a short-term loan.

A Harvard University Credit Union loan officer also can help you evaluate your alternatives. You may be able to restructure some existing debt to better manage your obligations. If you've run out of other options, weigh the projected long-term costs of a loan against the benefits before tapping your 401(k). If a loan will just delay the inevitable foreclosure or bankruptcy, then borrowing from your account could put you in the worst possible position: losing your home or filing bankruptcy now and having thousands of dollars less to live on in retirement.

Of course, the best way to avoid having to make the tough choice between present and future financial needs is to practice prevention. That includes self-insuring against a loss of income through an adequate emergency fund. Contact a HUECU representative for help determining how much of a cushion you need.