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Taking a loan from your 401(k) savings is generally a bad idea — but using the money as a short-term “bridge loan” can be an exception, according to Blair duQuesnay, a New Orleans-based certified financial planner.
“I’ve always been very opposed to 401(k) lending,” duQuesnay said. “However, I have found that there are instances in which it makes sense.”
In fact, she recently used this strategy herself when buying a new home. DuQuesnay, an investment adviser at Ritholtz Wealth Management and a member of CNBC’s advisory board, used a 401(k) loan as a short-term pot of cash for a down payment.
The retirement savings loan served as a bridge loan that duQuesnay plans to repay after selling his old home. She has no intention of selling until she has moved in and done some repairs.
This can be a good strategy for those whose budget can absorb monthly mortgage and 401(k) loan repayments, she said.
Advantages and disadvantages of a 401(k) loan
Federal law allows workers to borrow up to half of their 401(k) balance, capped at $50,000.
People should generally try to avoid borrowing from retirement savings if they can, however, duQuesnay warned.
When taking out a loan, it’s generally wise to do so to buy “good” assets — ones, like a home, that are expected to appreciate in value over time, duQuesnay said. Conversely, a car loan is an example of debt for a “bad” good since cars depreciate over time. Home equity is also typically the biggest store of wealth for people in retirement, she added.
Retirement savers shouldn’t borrow from their 401(k) to meet their day-to-day cash flow needs, which would speak to a larger budgeting issue, she said.
Of course, 401(k) loans have drawbacks, duQuesnay said.
For example, you take that money out of the stock market, which means you’ll miss out on investment income during the repayment period, which can typically be up to five years.
Even if you repay yourself with interest, the loan still represents a monthly cash flow squeeze.
Also, if you are laid off or find a new job, most employers will require your outstanding balance to be repaid shortly after termination. Failure to do so may trigger income taxes and, depending on your age and situationa tax penalty.
Some, but not all, 401(k) plans allow savers to continue making 401(k) contributions in addition to loan and interest payments, duQuesnay said.