No one should ever borrow from their qualified plan to live beyond their means.
However, firsthand experience confirms participants who take advantage of plan loans rather than the much more expensive alternative of consumer debt often improve their household wealth and retirement asset accumulations.
Surveys, like the American Payroll Association's "Getting Paid in America," show 71% of Americans live paycheck to paycheck — a one-week delay in the next paycheck would cause some or significant financial difficulty. The Federal Reserve's report on the "Economic Well-Being of U.S. Households" confirms 41% of adults do not have $400 to pay an emergency expense. The National Foundation for Credit Counseling reports that 38% of households carry a credit card balance. The Federal Reserve reported that revolving debt (mostly credit cards) was $1.027 trillion — $5,839 per adult with a credit card, with an average interest rate of 16%, and where 28% of payments were missed or delayed. The Center for Financial Services Innovation reports approximately 12 million Americans take payday loans each year, averaging $375 at a 400% interest rate and average cost of $520.
Department of Labor and IRS regulations require a reasonable rate of interest. Today, plan loans typically charge 1% to 2% above prime; most plans charge between 5% and 6%. Consider the aggregate annual return for the past six years for the Bloomberg Barclays U.S. Aggregate Bond index: -2.02% (2013), 5.97% (2014), 0.55% (2015), 2.65% (2016), 3.54% (2017) and 0.01% (2018).
So, a plan loan at 6% that avoids more than 16% consumer debt will improve household wealth (or reduce debt). And, given recent bond returns, if the participant maintains her investment allocation by treating the plan loan as a fixed-income investment, retirement assets also will increase.
In fact, research by Geng Li and Paul A. Smith of the Federal Reserve confirmed many workers would improve financial wellness by increasing use of plan loans.