Is it wrong to borrow from your 401(k) or take out a 403(b) loan, even for a child's college tuition fees or wedding?
Sometimes a big expense comes along that tempts you to borrow from a retirement account. This can be especially true if your child is facing an important, emotional life event, such as going to college or getting married.
Everyone loves a wedding, an occasion when normal standards of financial prudence are thrown to the wind like confetti. And college tuition fees can be a solid investment in your child’s future.
If your retirement plan provider allows you to simply borrow money from your 403(b), what’s the big deal? Borrowing from retirement to help your kids out is acceptable, isn't it?
The short, tough love answer is NO. Here's why it's generally NEVER a good idea to borrow from your retirement account:
- The whole point of putting money into a tax-deferred retirement account is the growth potential on that pretax money. If you take it out of your account beforehand, you will lose out on any appreciation that money may accrue.
- You have to pay that money back within a certain timeframe, generally within five years.
- The interest you pay back to your account is in after-tax dollars.
- If you terminate employment, most plans require you to immediately repay any outstanding amount, otherwise it will be treated as an early distribution, subject to ordinary income tax. In addition, it may be subject to the 10% early withdrawal penalty.
- It may seem like you are doing your child a favor. However, he or she is likely to pay the cost for it later, when you’re short of money in retirement due to an unwise financial decision, and they're left to carry the financial burden.
If you don't have the money already saved, don't do it.
Rather than help your child make a down payment on their first house or (worse) splurge on a wedding party, give him or her the more valuable gift of saying no. That may sound harsh but it's really an opportunity to teach that child about making the right financial choices—something valuable they can use throughout their lives.
Take the classic example of paying for a child's wedding: Unlike an emergency medical procedure, or leaking roof, a wedding is something that can wait. And once a date is set for the big day, it can still be scaled down to fit a modest budget. Think of all the frivolous spending that goes into the modern-day wedding—a whole industry fueled by ostentation and impressing people on social media.
When I got married, my husband and I hosted our wedding reception in the events-space basement of the same church in Harlem where the ceremony took place. Being members of the church meant we even got a discount on that modest expense. And what’s more, the pictures looked just as beautiful as those from a much grander affair.
Before meeting my future spouse, I had already opened a mutual fund account because I knew that it's always a good idea to set aside some money for a long-term, undefined goal. After getting engaged, my spouse and I started saving independently, in separate savings accounts. And although Mom helped out a little, she certainly didn't touch her retirement accounts to do so.
Set it—then forget it
Any money that goes towards your retirement should be forgotten about, plain and simple. Only when your actual retirement is approaching should you start thinking about it as your money.
For worthwhile expenses, such as education, there are always better lending options available to you and yours than having to borrow from retirement. Put time into researching the many financial programs designed to help people invest in their education. There are many advantages to student loans. For example, the interest on student loans doesn't start accruing until you complete your program.
To sum up: Watching your child get married or helping them through school should be a happy and emotional experience, but not because of how much money is spent on it. The bottom line is that making a big financial decision based on emotion could seriously jeopardize your own happiness in retirement.