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By Brian Mayfield
When you need money for an immediate expense, it’s hard to think about saving for the future. Many people tap into their retirement savings to cover it. It’s logical to want to take care of the expense quickly but taking money from a retirement account may have a long-term effect. There are alternatives to consider instead of borrowing from your future.
Taking money from an IRA, 401(k) or other retirement account—known as cashing out—will cost you in both the short- and long-term. It’s something you should think twice about. You’ll owe taxes and penalties, and it can significantly dent your retirement savings. The alternatives to cashing out have pros and cons, too, but can help keep your nest egg intact.
Homeowners can borrow against equity in their homes as long as they keep at least 20% equity in the house after the loan. With fairly low mortgage rates, a home equity loan may give you a good interest rate. Check with your mortgage company or other lenders to find today’s rates .
Home equity loans usually have fixed interest rates and terms, so the payment will stay consistent over time. There are also no restrictions on how you use the money, and you’ll receive it in a lump sum. On the downside, your home will be used as collateral, and you may have closing costs and fees, which sometimes can be rolled into the loan.
A similar option is a cash-out refinance , which is taking money out at closing when you refinance. This will increase your mortgage balance and may also impact your loan’s interest rate.
A second alternative is to take out an unsecured loan that doesn’t require collateral. These loans normally have higher interest rates, but you won’t be putting your home or any other asset at risk.
To get the best interest rates for a personal loan, your credit score matters. Another thing to note is that the interest you pay is not tax deductible like it could be on a mortgage loan.
Is it really cheaper to take a personal loan over withdrawing money from your retirement account? It can be in the long run. Consider current costs and future savings with both options.
This hypothetical example is for informational purposes only and does not represent any American Century Investments fund. It assumes a $5,000 loan at 5.99% interest paid back over five years with a $97 monthly payment. The investment amount assumes $5,000 invested over 27 years at a 6% interest rate. Source: American Century Investments, future value calculator by dinkytown.net, 2019.
Some credit cards offer a 0% introductory or balance transfer annual percentage rate (APR) that allows you to pay off the balance over a period of time without interest. Some also have rewards or cash-back benefits that can help in other ways. The key is to pay back your balance before the intro APR runs out. If not, you'll be charged back the interest at a rate that is typically much higher than a personal loan.
At the risk of sounding like I'm backtracking, there is a way to take a cash-out from a retirement account, but it means you have to put it right back. This would work for an IRA and also if you are rolling over a retirement account from a previous employer.
The IRS does allow you to redeposit the money in 60 days without penalties or taxes. You should only do this if you know you'll have the funds in that time period. Note the IRS considers this part of its "rollover rule" and allows it only one time in 12 months.
Again, don't miss repaying within the 60 days. Doing so could subject you to a 10% early withdrawal penalty, income taxes and possibly the loss of all tax benefits on your account. The bottom line? Proceed with caution.
A final option, which I'm not officially adding to my list because it can turn dicey, is to borrow from friends or family. It may cost less but could also have long-lasting repercussions on your relationships. You don't want to be "that" relative at family reunions who never paid back Uncle Bill.
There are several ways to set up family loans , but be aware of the right way to handle them. The goals are to protect your relationship, the friend or family member and not violate IRS rules.
It's nerve-wracking to have an expense for which you don't readily have cash. However, taking money from your retirement savings can make a lasting impact on how you live in the future. Review the alternatives before making a move.
Before considering a retirement cash out, talk to us. We can help you run numbers and discuss options.
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