Time to read: 4 Minutes

Most financial advisor firms know how to leverage debt to their clients, however there are always benefits and risks to this. Using debt strategically involves leveraging borrowed funds to achieve specific financial goals or cover unexpected expenses. Taking a loan out on your 401(k) can be a strategic way to handle medical emergencies, but it’s important to understand both the potential benefits and risks involved.

A 401(k) loan allows you to borrow money from your retirement savings account, typically up to a certain percentage of your vested balance or a maximum dollar amount. The loan is repaid through regular payroll deductions, usually over a period of years, although the terms may vary depending on your plan’s rules.

Benefits

Convenience:

Borrowing from your 401(k) can be a quick and relatively easy way to access funds without undergoing a credit check or facing stringent approval criteria, which can be crucial in urgent medical situations.

Lower Interest Rates:

401(k) loans often have lower interest rates compared to other types of loans, such as credit cards or personal loans. Since you’re essentially borrowing from yourself, the interest payments go back into your own account.

No Impact on Credit Score:

Because 401(k) loans aren’t reported to credit bureaus, they don’t affect your credit score. This can be advantageous if you’re concerned about maintaining or improving your creditworthiness while managing medical expenses.

Immediate Access to Funds:

In medical emergencies, time is of the essence. A 401(k) loan can provide quick access to the necessary funds without the delays associated with traditional loan approval processes.

Risks and Considerations:

Risk of Default:

If you leave your job or are terminated, the outstanding balance on your 401(k) loan may become due immediately. Failing to repay the loan on time can result in penalties and taxes, potentially eroding your retirement savings.

Opportunity Cost:

By withdrawing funds from your 401(k), you’re sacrificing potential investment growth, especially if the borrowed money isn’t used for purposes that generate higher returns.

Reduced Retirement Savings:

Even though you’re technically borrowing from yourself, taking a 401(k) loan can diminish the amount of money available for your retirement years. It’s crucial to weigh the short-term financial need against the long-term impact on your retirement nest egg.

Tax Implications:

While 401(k) loans are typically tax-free if repaid according to the terms, any portion of the loan that isn’t repaid, either due to default or early withdrawal, may be subject to income taxes and possibly a 10% early withdrawal penalty if you’re under 59½.

Using a 401(k) loan strategically can be a viable option in medical emergencies, providing quick access to funds with favorable terms. However, it’s essential to carefully consider the potential risks and weigh them against the benefits before deciding to borrow from your retirement savings. Additionally, exploring alternative sources of funding and seeking advice from a financial advisor can help ensure that you make informed decisions aligned with your long-term financial goals.

Additional Disclosure:

The Tranel Group is a registered investment advisor. Registration does not imply a certain level of skill or training. This presentation is for informational purposes and should not be taken as a recommendation. There is no guarantee that the opinions expressed herein will be valid beyond the date of this presentation. The Tranel Group does not offer tax advice or tax accounting matters to clients. The recipient should not construe the contents of this presentation as legal or tax advice and contact their own professionals for legal and tax advice and other matters relevant to the suitability of an investment for the recipient.