The $2.2 trillion coronavirus relief legislation enacted in March came with several retirement provisions to ease the pandemic’s financial burden on Americans.
Among them, Americans now can borrow up to $100,000 or 100% of their retirement account — whatever is smaller — if they are suffering from a COVID-19 economic hardship. The limit before the CARES Act was $50,000 or half the savings in the account.
Borrowers can also delay any repayment obligations for 401k loans in 2020. Typically, a loan must be paid back in equal installments over five years with interest.
While taking out a loan is the easy part, paying it back is often a test of discipline, experts said. Here’s how to avoid penalties and approach your new debt if you took out a 401k loan.
‘Slow and steady wins the race’
“Slow and steady wins the race when it comes to paying off debt,” said Jacqueline Schadeck, a certified financial planner at Sherrill & Hutchins Financial Advisory. “Your 401k provider will often have you start paying back your 401k loan from your paycheck, which is a forced way to repay that money and oftentimes the easiest way for people to pay that money back.”
More than 1 in 4 of Americans have tapped into their retirement accounts or are planning to do so during the pandemic, according to a recent study by personal finance site Bankrate.com.
“If you can’t repay the loan, it is considered defaulted, and you will be taxed on the outstanding balance, including an early withdrawal penalty if you are not at least age 59 ½,” said Schadeck. “The worst thing to avoid when it comes to paying off debt is feeling overwhelmed and giving up. Remain consistent in your payments no matter how small they are.”
Read more: 401(k) Plans and how it works
If you haven’t had a conversation with your employer about how to pay back your loan, it doesn’t hurt to initiate the conversation.
"If you have borrowed from your 401k, get started with your payback plan by setting up an automated savings plan so that you put your savings plan on autopilot,” said Rhian Horgan, CEO of Silvur, a retirement planning app for Baby Boomers. “Your 401k provider will tell you how you can transfer funds to repay the loan."
‘Create an organized and structured plan for repayment’
If you don’t have an automatic option to pay back your loan, sit down and examine your budget.
“Putting a payment plan in place to begin paying the loan back is the best way,” said Amit Chopra, a certified financial planner at Forefront Wealth Management. “Step one would be to get organized with a budget, so you can determine what you are capable of paying back each month.”
Make sure to consider other debts that need to be paid. Almost 1 in 6 who tapped their retirement savings said they already had additional debt.
“People don’t get in trouble borrowing money, they get in trouble when they have no idea how they plan on paying it back,” Chopra said. “If you know your time frame, you can now back into how much you need to be paying or putting aside on a monthly basis.”
The recent CARES Act provision gives adults up to six years to pay back their 401k loans.
‘Be wary if you’re leaving your job’
If you have taken out a 401k loan, experts warned that leaving a job means you have to pay back the full amount right away.
"It's important to assess the longevity in which you'll be at your employer to know the time frame of when you will need to pay back your loan,” said Dan Slagle, founding partner at Fyooz Financial Planning. "If you have aspirations to work elsewhere in the short term, then identify other means than a loan from your 401k.”
But if you are fortunate to not be a part of the large pool of unemployed Americans during the pandemic, experts said take the loan, but practice consistency.
“Again, It's best to attack this in small increments to not get overwhelmed,” said Schadeck. “Start by determining what will need to be paid back and then create a savings plan for yourself to get that debt satisfied.”
Read more information and tips in our 401k section