Why borrowing from your retirement plan is a bad idea

September 2, 4:27 PMJobs and Careers ExaminerKristina Cowan

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Borrowing from retirement plans is an increasingly popular trend, research shows, but not necessarily a good one. Late last week, Fidelity Investments released research indicating that 40 percent of workers in Generations X and Y cash out their workplace savings plans when they change jobs.

A July report from the Center for American Progress says "as the housing crisis grips the country, more and more individuals are tapping their 401(k)s." Hampered by slow income growth, people turn to their retirement savings to help meet rising costs of homes, food, energy and health care, the report explains. But even a small loan of $5,000 (in 2008 dollars) could significantly cut a worker's savings: "a 401(k) plan participant who takes a loan to smooth over an economic rough patch, and makes only the loan payments, reduces their total retirement savings between 13 percent and 22 percent."

The National Center for Policy Analysis offers another illustration. A 35-year-old worker who borrows $30,000 over five years from a 401(k) plan with $60,000, for example, could end up shrinking his retirement income by $30,000 a year.

Given the dicey economy, it makes sense that workers are seeking refuge in their retirement savings. Yet, as the NCPA warns, workers should avoid that at all costs. "Even in extreme situations, it is best for workers to seek other sources of capital before tapping their 401(k) accounts. Otherwise, borrowers are leaving much of their potential earnings on the table. A small loan now can equal a huge loss in future retirement security," according to a brief by Robert Reeves and Pamela Villarreal.

In the meantime, the CAP is urging policy-makers to step into the fray, suggesting they come up with policies to improve income growth and provide health and unemployment insurance to workers unexpectedly facing health issues or layoffs.

With any luck, perhaps our lawmakers will do something to help reverse the 401(k) borrowing trend.