Be careful when borrowing from a 401(k), as it often sets retirement savers on a negative track, research from Fidelity Investments
The analysis of 13 million investors reveals a growing number are taking 401(k) loans. More than one in five people are now tapping their retirement savings for cash, USA Today
says the Fidelity data show.
And it's costing many Americans more than they realize.
Some 40 percent of those who take a loan fail to maintain their previous rate of savings, and more than one-third stop contributing altogether within five years of borrowing the funds.
In fact, according to Ric Edelman, CEO of Edelman Financial Services,
some plans do not allow borrowers to contribute until their loans are repaid.
Aggravating matters is the fact that half of those who take 401(k) loans become "serial borrowers," returning to their retirement pool for additional loans.
"They're almost treating their 401(k) like a checking account. If you're never paying a loan off in full, you're constantly playing catch-up," Jeanne Thompson, vice president of thought leadership for Fidelity tells USA Today.
The popularity of 401(k) loans is growing because it's the predominant alternative to the once popular home-equity loan, which began to evaporate after the 2008 credit crisis, Edelman writes in a guest commentary for CNBC
One reason the trend is so troublesome is that it's counter-intuitive to the premise of retirement investing, which relies on the magic of compounding. That power is lost when you pull money from your account, because you're actually selling assets that are no longer able to bring you profits.
Once borrowers reach their retirement years those lost years of growth can translate in substantially lower monthly income, Fidelity reveals.
For example, if an investor who was saving 10 percent cuts back and only saves 5 percent for five years, he'll receive nearly $200 less each month in retirement. And if he stops saving altogether for a decade, his retirement income will be reduced by approximately $700 less a month.
"I don't think that's something people think about when they take out the loan," Thompson says. "Think about what you could do with $690 a month in retirement," she told USA Today.
Moreover, Millennials account for many of the largest loans, because they are tapping their retirement funds to buy homes. The problem there is Millennials also have a tendency to only stick with a single employer for a few years.
A 401(k) loan must be repaid in full when you leave a job or there is a stiff tax bill and penalties to pay, Thompson explains.
Taking a 401(k) loan is an option that's generally best avoided, Edelman argues. Find another source of cash. Let your account grow without setbacks and enjoy a more comfortable retirement, he advises.
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