Robbing Peter To Pay Paul?
Loan programs typically are positioned as an opportunity for participants to borrow from themselves and to pay themselves back with interest.
Illustration by JooHee Yoon
Of course, that rate of interest is typically lower than the participant could earn in the retirement plan (depending, of course, on the period of time in question, and the relevant interest rate) and it has to be paid on an after-tax basis, to boot.
Most participant-directed retirement programs today offer participants the ability to borrow against their accumulated savings for a variety of reasons, both significant and mundane. It has long—and perhaps rightly—been viewed as an important incentive in encouraging workers to participate in the program.
Moreover, in situations where the loan is repaid, where their regular retirement plan contributions are not reduced (at least no more than they might have been to repay a loan taken from a source outside the plan), where the loan interest rate is lower than that payable to a commercial source, the participant’s overall financial situation might even be improved (note also that, in a perfect world, the participant would reallocate the retirement investment portfolio to reflect the nature of the loan holding as a fixed-income investment).
Still, taking money from the plan, however temporarily, runs counter to the basic premise of tax-deferred savings. Every day the money is not in the plan, the participant loses ground in saving for retirement. On the pages that follow is my attempt to outline the considerations in a manner directed to participants.
I hope it helps you—and your participants—make a choice that represents a good balance of their current need for cash with their need for cash in the future. As always, I appreciate your feedback.
Nevin E. Adams