As the COVID-19 crisis continues, the severity of the economic impact on households is becoming clearer and more widespread. For some, the impact may be prolonged. As the ability to postpone creditor payments diminishes over time and emergency savings whither, it would only be natural to wonder if you should consider borrowing from your future. That is, taking a loan from your workplace retirement account, such as a 401(k), 403(b) or 457(b) account.The March 2020 CARES Act anticipated this decision. Per the Act, the amount that you can borrow from your workplace retirement account was raised to $100,000 and can be up to the full balance of the account. And for previous outstanding loans (loans entered into before the enactment of the CARES Act), payments due this year can be postponed for up to a year. Importantly, these new rules only refer to “qualified individuals.” As the law is written, the only person who can take advantage of these special provisions is a person who is diagnosed with COVID-19, has a spouse or dependent who has received a diagnosis or is personally affected by the resulting economic downturn.
If, for example, a husband loses his job or his wages are reduced due to the economic downturn, the loan cannot come from his wife’s retirement account and benefit from these new provisions. Non-qualified individuals, of course, can still take out a workplace retirement account loan under the old rules which limit loans to $50,000, and cannot exceed one-half of the account balance.
So, we know that you can take a loan from your retirement account. But should you? First, a primer on how retirement account loans work. When you take a loan from your retirement plan, you pay it back automatically through a payroll deduction. This means that you can only take a loan if you are currently employed; you cannot take a loan from an “old” 401(k) (or similar) account with a previous employer. The period of the loan usually cannot exceed 5 years.
Interest is charged, usually just a few points above the prime rate, however this interest payment flows back into your account. Compared to alternatives such as using a credit card, the cost of a workplace retirement account is often less. As well, the process for obtaining a loan is generally easy and does not require a credit check.
The decision to take a loan from your workplace retirement account is not a decision to be made lightly. It is quite literally a loan today from your future self that can impact your retirement security later. However, in times of financial stress, this may be the bridge that you need to stability.