Should I Take a $100,000 Loan from My 401(k)?

The government’s new stimulus bill aims to provide relief to people facing financial challenges as a result of the coronavirus pandemic, including announcing an exception that would permit 401(k) plan holders to withdraw up to $100,000 to alleviate financial pressures they’re facing as a result of coronavirus.

How do 401(k) loans work?

• Typically, 401(k) withdrawals before age 59 ½ are not permitted.

• Typically, early withdrawals are subject to income tax plus a 10% early withdrawal penalty.

• There are a few exceptions, including financial hardships from medical expenses or disasters, e.g. Hurricane Maria and now: coronavirus aka coronavirus-related distributions (CRDs).

What’s different about CRDs?

• Higher limit: Typically, $50,000 has been the maximum amount that could be borrowed in a hardship withdrawal. With these withdrawals, up to $100,000 (or, if you don’t have $100,000, then the vested account balance) is available to be borrowed. 

• There’s a window: For the calendar year 2020, the window to borrow funds between March 27th and September 23rd. 

• Distributing the taxes: You can pay any taxes due over a three-year period. If you pay borrowed funds back within three years, it’s treated as a rollover and not subject to taxes. 

• Eligibility criteria: You may be eligible if you or a loved one is diagnosed with coronavirus, or if you experience financial consequences as a result of coronavirus.

Before you act…

While many people may need access to money today, is taking it from your 401(k) the most efficient way?

Not likely; it’s costly and it could even compromise your ability to retire.

• $100,000 withdrawn now is actually worth more than $400,000 over time (assuming a 5% average return over 30 years).

• The actual cost is likely even higher than this, given that the market is at a low and could rebound significantly in the next year or so. For example, if the market were to recover in the next year, then someone taking a loan could effectively pay a 20-30% interest rate to withdraw that money for a year and miss out on market appreciation.

Furthermore, how many people even have access to that much in their 401(k)? 

According to data from Vanguard, the median 401(k) balance is just over $22,000. Their data suggest that only 1 in 5 people with a 401(k) would be able to access the full $100,000 outlined in the CARES Act. For the more than 45 million 401(k) participants who don’t have a $100,000 balance, this just may not be as big an opportunity to find emergency funding.

What should I do?

• Protect your 401(k) for your future self. The strongest savings tool you have available to you is time in the market. Taking money out when the market is down can ruin the gains you’ve made.

• Before taking a loan from your 401(k) or any source, explore all the options you have for borrowing money. That might include loans, debt forgiveness, lease payments, etc.

• Check with your 401(k) plan administrator to see if your plan allows loans.

• Talk to your financial advisor for personalized guidance and advice.