There are myriad reasons why you might need quick access to ready cash right now. If you find yourself in this situation, you might be tempted to take out a loan from your 401(k) account.
More than eight in 10 workers have the option to take out a 401(k) loan. However, fewer than two in 10 of those who had this option had used it at the end of 2020, according to the most recent research from the Investment Company Institute (ICI).
Whatever your reasons for considering a 401(k) loan, here are some alternatives that might be better suited to your circumstances and goals.
Why Consider a 401(k) Loan Alternative?
If you’re looking for a 401(k) loan alternative, chances are you fall into one of these categories:
- You’ve heard 401(k) loans can be a bad idea.
- You need more money than you could get from a 401(k) loan.
- You don’t want to sell your 401(k) investments.
- You want to avoid the risk of a balloon payment if you lose your job.
- You don’t have access to a plan loan.
While a 401(k) loan might help you pay for major expenses like a medical procedure or higher education, most people’s loans are relatively small. That’s because IRS rules limit plan loans to 50% of your vested balance or $50,000, whichever is less.
This means that if you had the median 401(k) balance—about $18,000 at the end of 2020—you would only be able to borrow $9,000, while the average unpaid balance at the end of 2020 was less than $8,000 and the median was just over $4,000.
Cash Alternatives to 401(k) Loans
If you’d prefer not to borrow money at all, whether from your 401(k) or another source, consider these cash alternatives to a 401(k) loan.
Liquidate Company Stock
If you have company stock from an employee stock purchase plan (ESPP), you could sell it off. If you’re currently participating in an ESPP, you could also stop contributing and get a slight increase in your take-home pay.
Keep in mind that locking in gains will increase your tax bill while taking a loss creates an opportunity for tax-loss harvesting. And if you’re selling stock you’ve owned for one year or less, short-term capital gains tax rates will apply. These are higher than long-term rates.
Liquidate Other Assets
You might also consider selling non-financial assets. Anything you don’t use or don’t need could be an option: sporting event or concert tickets, NFTs, furniture, collectibles, sports or exercise equipment, jewelry, baby items, electronics, musical instruments or toys, for example.
In most cases, you’ll be selling these items at a loss. But it’s become harder to sneak gains by the IRS now that certain payment apps like PayPal and Venmo have to issue 1099-Ks once you exceed a certain dollar threshold for goods and services transactions in a calendar year. And collectibles have higher capital gains tax rates than most other assets.
Reduce Retirement Contributions
This option won’t give you a lump sum right away. However, it might work in conjunction with another option to free up enough monthly cash flow that you can leave your 401(k) alone.
Get an Unsecured Loan Instead of a 401(k) Loan
Maybe you don’t have other assets to sell—or there’s just no logic in selling your brand-new sofa for 75% off. Instead, these alternatives to a 401(k) loan could be a good choice if you don’t have a home (or enough equity) to borrow against.
Open a 0% APR Credit Card
Instead of borrowing from your 401(k), consider a 0% APR credit card. The best 0% APR credit cards will let you make purchases for at least 12 months without having to pay interest—as long as you make your minimum credit card payment on time each month.
Many of these cards also have no annual fee and will even give you a sign-up bonus worth at least $200 if you meet a minimum spending threshold within three months of opening your account.
However, if you can’t pay off your balance in full before the introductory period ends—or if you miss a monthly payment—you’ll lose the 0% rate. The interest charges you’ll incur could make you wish you’d gone with the 401(k) loan.
If you are well-organized and disciplined, this option could work out well. If your executive function isn’t the best, the automatic repayment structure built into 401(k) plan loans gives them an advantage.
Get a Personal Loan
A personal loan could provide you with $1,000 to $50,000 within a few business days. The interest rate will be fixed and the repayment period is typically two to seven years. If you have excellent credit, your rate might be a few percentage points higher than what the best high-yield savings accounts pay.
A personal loan might be a good alternative to a 401(k) loan. However, personal loan rates can be as high as 36% for borrowers with below-average credit. In that case, a 401(k) loan will be far more affordable.
401(k) Loan Alternatives for Homeowners
If you own a home and your equity is more than 20%, here are three more ways to consider borrowing money instead of dipping into your retirement savings.
Take Out a Home Equity Loan
A home equity loan lets you borrow one lump sum at a fixed rate. You can take up to 30 years to pay it back in equal monthly payments. The best home equity loan rates may be a couple of percentage points below the best personal loan rates.
You’ll pay closing costs of 2% to 5% of the amount you borrow. A home equity loan is one of the lowest-interest alternatives to borrowing from your 401(k) plan and one of the best ways to borrow a large sum.
Get a Home Equity Line of Credit
A home equity line of credit (HELOC) lets you borrow any amount, up to your credit limit, as you need it. The interest rate changes when market conditions change, making payments somewhat unpredictable.
Many lenders allow you to make interest-only payments during the draw period (up to 10 years). During the repayment period (up to 20 years), you’ll make full amortized principal and interest payments.
The best HELOC lenders often waive the closing costs as long as you don’t close your credit line within the first three years. A HELOC can be a good alternative to borrowing from your retirement savings if you want the option to borrow a large sum but the flexibility to borrow less.
Do a Cash-Out Refinance
A cash-out refinance replaces your existing mortgage with a new, larger mortgage. The excess goes back to you as cash. You can get a fixed-rate loan with a repayment term as long as 30 years and fixed monthly payments. Adjustable-rate loans may be an option, too.
As with a home equity loan, closing costs of 2% to 5% typically apply. This alternative to a 401(k) loan could make sense if you wanted to refinance anyway.
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