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Here’s where taking a 401(k) loan actually ‘makes sense,’ says advisor

BusinessReal EstateHere's where taking a 401(k) loan actually 'makes sense,' says advisor
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Taking a loan against your 401(k) savings is generally a bad idea — but using the money as a short-term “bridge loan” may be an exception, according to Blair DuquesneA Certified Financial Planner based in New Orleans.

“I’ve always been very opposed to 401(k) loans,” Duquesne said. “However, I have found that there are some instances in which it makes sense.”

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In fact, she recently employed that strategy herself when purchasing a new home. DuQuesnay is an investment advisor at Ritholtz Wealth Management and a member of CNBC’s Advisory CouncilA used 401(k) loan As a short term pot of cash for the down payment.

Borrowing against retirement savings serves as a bridge loan that Duquesne plans to pay back after she sells her old home. She doesn’t intend to sell until after going out and doing some repairs.

This can be a good strategy for people whose budget can absorb monthly mortgage and 401(k) loan payments, she said.

Pros and Cons of 401(k) Loans

Federal law allows employees to borrow up to half of their 401(k) balance, capped at $50,000,

People should generally try to avoid borrowing from retirement savings, however, Duquesne cautioned.

When taking out any type of loan, it’s generally wise to do so to buy “good” assets — those, such as homes, that are expected to appreciate in value over time, Duquesne said. In contrast, an auto loan is an example of a loan for “bad” assets because cars depreciate over time. He noted that home equity is typically the largest store of wealth people have in retirement.

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Here are more perspectives from the FA Council on how to navigate this economy while building wealth.

Retirement savers shouldn’t be borrowing against their 401(k) to meet their everyday cash flow needs, he said, which would speak to a broader budget problem.

Of course, there are drawbacks to 401(k) loans, Duquesne said.

For example, you’re taking that money out of the stock market—which means you’ll miss out on investment earnings during the payback period, which can typically be up to five years.

Even though you’re paying yourself back with interest, the loan still represents a strain on monthly cash flow.

In addition, if you are laid off or find a new job, most employers will require you to pay your dues immediately after termination. Failure to do so may trigger income tax and, depending on your age and circumstancesa tax penalty.

Duquesne said some but not all 401(k) plans allow savers to continue making 401(k) contributions in addition to loan and interest payments.

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