While it’s generally a bad idea to dip into your retirement savings early, there are certain situations where borrowing on your 401 (k) before retirement “makes sense,” said Catherine Golladay, president of Schwab Retirement Plan Services. . CNBC do it.

“Generally speaking, people should only borrow from their 401 (k) as a last resort,” says Golladay. However, “it might be the right decision if you don’t anticipate any change in your professional situation and are still on your way to retirement overall.”

If your situation warrants it, asking your 401 (k) for money is “a much simpler process than applying for an external loan,” Golladay explains. But keep in mind that when you pay it back, “you are paying the principal and interest on the loan on your own account.”

While Golladay says this essentially makes the loan “interest-free,” what she means is that 401 (k) repayments are paid by the borrower to their own 401 (k) account, rather than to a third party such as a Bank. You still pay interest to borrow money, but it comes back to you. As long as you can continue with current payments without defaulting, this interest model can be a nice benefit, but remember that all 401 (k) loans must be repaid. within a five-year window.

Although you should pay attention to all potential drawbacks to take a loan from your 401 (k), as well as to have a realistic plan to pay it off if you do, there are three times this can make sense.

Buying a home is a big expense, and as a result, over 10% of Americans have tapped into their retirement savings to make a down payment on their first home. according to the discount rate.

That’s not necessarily a bad thing: “There are certain circumstances in which taking out a 401 (k) loan can make sense, like making a down payment on a house, which is a financial goal in itself,” Golladay says. .

If you choose this option, it is important to “make sure the loan amount doesn’t prevent you from continuing to save for retirement,” Golladay explains. You want to be able to keep saving on top of paying off the loan.

When it comes to determining how much to take out on a loan, “less is more,” says Ryan Marshall, a certified New Jersey-based financial planner. “The maximum 401 (k) loan amount is usually 50% of the acquired balance or $ 50,000, whichever is less,” he explains. However, “I would say try to keep it at 10% of the portfolio or $ 10,000.”

Another thing to take into account is the housing market. In general, you should always ask yourself if you plan to buy in “a favorable market for buying real estate,” says Golladay. Is it worth buying now or do you need to keep saving while waiting for better market conditions?

Paying off high-interest debt is another potential reason to take out a 401 (k) loan, Golladay says.

This is because the prime rate, or the interest rate charged by banks on loans, is currently 5%, said Marshall. The interest 401 (k) borrowers pay back usually barely one or two points above the prime rate, which is much better than the 19-20% that some high-interest credit cards charge, he explains.

However, before you take out a 401 (k) loan to pay off debt, you must exhaust all other options, Marshall says. This includes making extra money by getting side or part-time work, or by selling old goods.

“There are many other ways to pay off high interest rate debt and I would never recommend withdrawing your retirement until all other options are exhausted,” Marshall said. But, in case of absolute necessity, he recommends you take a 401 (k) loan, instead of a 401 (k) hardship withdrawal, since the two come with different terms.

“There are 401 (k) plans that allow you to take a loan out of the account rather than making a withdrawal. With a withdrawal, it becomes taxable and there is a 10% penalty,” says Marshall. “However, when you take out a loan, you are essentially borrowing from yourself and there is no tax implication for that transaction.”

Sometimes it makes sense to take out a 401 (k) loan when you’re in a temporary period of financial need and need to cover expenses until you come back to a more secure situation, Golladay says.

“Imagine a scenario where a spouse is laid off from their job and the family struggles to make ends meet on just one income,” Golladay says. “The employed spouse can borrow from their 401 (k) to fill the gap, then pay off that loan quickly once the other spouse finds a new job.”

If it is a specific need that you are trying to fund, such as permanent disability or medical expense coverage, 401 (k) plans typically offer withdrawal waivers where the additional 10% tax would be charged to you. usually charged on withdrawal is removed.

“There are different exceptions that qualify for a 10% early withdrawal waiver,” Marshall said. “I recommend finding out if you qualify for the waiver and using the funds in the appropriate account to fund your needs.”

Be aware that there are consequences that could potentially come from an early raid on your 401 (k). On the one hand, withdrawing money before retirement (or before the age of 59 and a half) often results in penalties and fees.

Even if you take out a loan that you plan to pay off, the pre-tax money you borrow on your 401 (k) will ultimately have to be paid back in after-tax dollars.

It should also be noted that if you quit your job or are made redundant, you will need to pay off your 401 (k) loan within a few months. Otherwise, it counts as a distribution, which triggers income taxes and possibly an additional 10% tax penalty on the loan balance, Golladay says.

That’s why it’s important that you have a solid plan in place to pay it off in a timely manner, says Golladay. Although borrowers have five years to pay off 401 (k) loans, doing so in three years or less is ideal, she says.

“By writing a financial plan, preferably with the help of a knowledgeable professional, you can take into account and prepare for potential challenges with the aim of ensuring short-term stability and comfort in retirement,” explains Golladay.

Ultimately, withdrawing funds from your 401 (k) early derails your retirement savings efforts. The pre-tax money 401 (k) participants contribute is intended to grow over the course of their careers, Golladay says. By taking out a loan, you miss tax-deferred growth in the form of returns on investment on that part of your savings until the funds are repaid.

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