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When 401(k) Loans Make Sense

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Some producers advise their boomer clients not to borrow against their 401(k) plans because those assets are, after all, earmarked for retirement–a life stage getting terrifyingly close for many boomers.

But at the same time, boomers often have collected a sizeable 401(k) stash after saving for so many years. And for one reason or another, many do want access to some of those funds.

Its now easier than ever to borrow from a 401(k) plan, since the IRS late last year did away with limits on the number of loans a person could take out on his or her plan assets.

(Participants still cannot borrow more than half of accumulated plan assets or $50,000, whichever is less.)

Michael Waddell, a retirement consultant with Watson Wyatt Worldwide, Washington, thinks arguments against borrowing against a 401(k) account often dont hold water.

“The hard question is, suppose you have to?” says Waddell. “It may be better to take it out of your 401(k) than elsewhere.”

The big advantage of a 401(k) loan is its low interest rate, often only a percentage point above prime, he notes.

Moreover, Waddell says, “Its just easy to do. Its a matter of calling a toll-free number. There are no application forms. And you can have a check in a week.”

Its true that someone borrowing from a 401(k) must repay the loan with after-tax money, he says. And later, when the person retires, that same money is taxed again.

“But the same thing happens with loans from someplace else, so thats not really a disadvantage,” Waddell says. “The fact it was borrowed from a bank or a 401(k) doesnt make a difference.”

One criticism of 401(k) loans concerns the lost opportunity costswhat the borrowed money might have earned if it had been left in the account.

“But the stock market doesnt go up 20% a year,” Waddell argues, “so I wouldnt worry so much about decreasing what you are going to get on your assets.”

Robert M. Mrazik, a consulting actuary with Conrad M. Siegel Actuaries, Harrisburg, Pa., says 401(k) loans are partly an investment decision.

“You are borrowing from yourself. What youre doing is locking it in at 4% or whatever. Now, compared to what you might make if you had some of that money in the market, you might be losing money. But who knows? My personal feeling is that there is not always a clear-cut answer.”

Another expert sees loans as one of the most important selling points of 401(k) plans.

“In general, the availability of loan provisions enhances the participation of younger people and generally results in a higher contribution on average,” says John Blossom, president of Alliance Benefit Group, Peoria, Ill. “If they know they can have access to their funds in an emergency, they are more likely to set money aside than if there were no loan provision.”

Moreover, he adds, “if you have the ability to pay it back, a 401(k) loan makes sense because you have been able to accumulate those funds pretax, often aided by company matching.”

Another consideration: “If you look at the last five years or so of the life of my own 401(k) loan, I paid myself 8% interest, so I had what amounted to fixed income investment,” Blossom says.

Thats a key point for boomers, who are at an age where fixed-income investments are more important than when they were younger, he notes.

Did You Know?

401(k) plans with a loan feature have 35% higher contribution rates on average than those without a loan feature.

Source: U.S. General Accounting Office

Reproduced from National Underwriter Life & Health/Financial Services Edition, October 24, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.