Participating in the company’s retirement plan is a smart (and important) decision. Smart because you are putting away small amounts today for a comfortable retirement later.
As your account begins to grow, it may be tempting to “dip into” your retirement savings by taking a loan against your retirement plan to pay your annual taxes, repair a leaking roof, catch up on your everyday pile of bills and so on. And while the decision to take a plan loan is yours to make, we want to ensure that you consider what it will really cost.
With a retirement plan loan, you pay yourself back the amount plus interest. But the true cost can be shown with the loss in your retirement savings. You lose money when you borrow from your retirement account for several reasons.
- You lose making money on the earnings, or compounding of those earnings.
- You repay the loan with after-tax dollars.
- There is (typically) an initial set-up and quarterly loan fee.
- Most employees decrease the amount they are contributing in order to compensate for the loan payment.
- You may not be paying yourself back the same amount you would have earned if you left the money invested (you pay yourself 7 percent, but could make 10 percent).
To further illustrate the costliness of taking a plan loan, consider the following hypothetical example*:
Jane took a $10,000 loan at 7 percent interest from her retirement account; her account balance before the loan was $20,000. She previously made contributions of $150 per paycheck (including the employer match). Because she had to repay the loan, she decreased her contribution to $50. Additionally, prior to the loan, she was earning a 10 percent return. Now she will repay the loan over five years. If you take into account loss of interest, compounding, and tax on repayments, the actual retirement plan loan is costing Jane 13.77 percent! Don’t forget about those decreased contributions, which can add up to hundreds of thousands of dollars over many years.
Securities offered through IFP Securities, LLC, dba Independent Financial Partners (IFP), member FINRA/SIPC. Investment Advice offered through IFP Advisors, LLC, dba Independent Financial Partners (IFP), a Registered Investment Adviser. IFP and Ridgeline Advisors are not affiliated.
The information given herein is taken from sources that IFP Advisors, LLC, dba Independent Financial Partners (IFP), IFP Securities LLC, dba Independent Financial Partners (IFP), and it advisors believe to be reliable, but it is not guaranteed by us as to accuracy or completeness. This is for informational purposes only and in no event should be construed as an offer to sell or solicitation of an offer to buy any securities or products. Please consult your tax and/or legal advisor before implementing any tax and/or legal related strategies mentioned in this publication as IFP does not provide tax and/or legal advice. Opinions expressed are subject to change without notice and do not take into account the particular investment objectives, financial situation, or needs of individual investors. Prepared by 3rd party.
*This example is hypothetical and intended for illustrative purposes only. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney or tax advisor with regard to your individual situation.
This material is not intended to replace the advice of a qualified attorney, tax advisor, investment professional or insurance agent.