This spring, Congress passed the CARES Act for those impacted by the pandemic. The landmark bill has several provisions for those facing financial difficulties—including one for those looking to borrow from their retirement accounts. The new rules provide temporary access to your 401(k) with fewer penalties and restrictions.
If you have borrowed 401(k) money, you may be starting to think about your payoff strategy. Whether you’re worried about job security or lost earnings, it’s important to craft a plan. Here are some things to consider before you start making payments.
Know the rules
Before paying back your 401(k) loan, it may be helpful to know the rules. The CARES Act boosted the limit for 401(k) loans from $50,000 or 50% to $100,000 or 100% of your vested balance. You still have five years to pay back 401(k) loans, but the new rules allow you to delay payments for one year.
“Borrowing from your 401(k) can be risky, so be sure to consider all your options,” says Leona Edwards, a Nashville-based wealth manager at Mariner Wealth Advisors. If you lose your job or decide to [work] elsewhere, you may have to repay the entire 401(k) loan balance. When you can’t, the loan becomes part of your taxable income, along with a 10% early withdrawal penalty.
You will also have to pay interest on your 401(k) loan. The rates can’t be better than a similar loan from a bank, according to the IRS—but the interest goes back into your 401(k).
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Refinance your mortgage
If you’re short on cash and eager to repay your 401(k) loan, it may be worthwhile to consider a mortgage refinance. With 30-year interest rates at record lows, Edwards says it may be a good opportunity to tap your home equity. “You should consider the closing costs, though,” she says, which could be between 2% to 6% of your loan.
Apply for a home equity line of credit
Another way to tap your home equity is through a home equity line of credit (HELOC). It may offer a 10-year payoff timeline, which is longer than the deadline to pay down your 401(k) loan. It’s not a risk-free option, though. “You could lose your home if you can’t afford the HELOC payments,” Edwards warns.
Pause college savings plans
Parents saving for college may consider a temporary pause to their plan. If your children are younger, there may be plenty of time to reconsider your college savings options. “Prioritizing your 401(k) loan payoff may help you avoid taxes and penalties,” Edwards says.
Consider the opportunity cost
Another reason to pay off your 401(k) loan? It allows more time for your money to grow. The sooner you pay off the loan, the greater the opportunity for tax-deferred growth. A few years out of the market may not seem like much—but it may equal thousands of dollars in lost future earnings. You can enter your loan details into a compound interest calculator to see for yourself the impact of an earlier repayment.
