You won’t believe what I’ve been hearing at work lately. Fellow employees are borrowing from their 401k accounts. Why do people take out loans against their 401k accounts and borrowing from 401k accounts when instead they should be looking at doing a maximum 401k contribution? I don’t know if there are people out there giving advice to do this, but it’s probably one of the worst ideas I’ve ever heard of. In fact, I would peg it up there with not saving for retirement at all!
After listening to a conversation about how this is a great strategy in this recession, I had to set the record straight and educate my friends at work. Someone has to do it right? Well, to sum up the multiple conversations I’ve had, here are five of the reasons why you should never borrow from 401k.
If you do borrow, time is no longer your best friend
Money grows over time, everyone knows that. And if you are investing regularly, time is truly your best friend. I’ll take a known statistic for example. Most of the time, your money doubles every eight years on average. For someone who is investing and not tapping into their 401k plans like a savings account, this is great news. However, if you withdraw money from your 401k plan you are missing out on serious growth opportunities. There are many reasons people take 401k loans, but many Americans take out money for a mortgage. 401k rules allow for these loans to be taken out for up to 5 years, and up to 15 years for a home purchase. If you borrow from your 401k, you are missing out on opportunities for your money to grow among other things. Over the long haul, this could mean the difference between $50,000 and $500,000. I don’t know about you, but I don’t want to miss out on the potential long-term growth prospects for my retirement money.
Losing money is not fun
You wouldn’t throw money out your car window, now would you? Yeah, didn’t think so. So why do it with your 401k money? Because that’s essentially what you’re doing when you borrow from your retirement account. And don’t use the excuse that paying yourself back the interest is boosting your savings. The long term return on your money makes the average interest rates today look like chump change. Don’t buy into this and avoid borrowing from your 401k. And don’t let me get into tax implications. To repay a 401k loan, you are using after tax money from your paycheck, which means anything above and beyond the principal repayment will be taxed a second time when you make a distribution from your account. That’s a bum deal.
Like a bird in tar, you are trapped
While speaking with my coworkers, many did not realize that a 401k loan stipulates that if you quit or lose your current job, the 401k must be repaid almost immediately. In effect, this is a type of leash that could force you to stay at your job and prevent you from seeking other higher paying opportunities. I can’t imagine having this freedom taken away from me. Even worse, if you unexpectedly lose your job after borrowing a large chunk of your retirement plan you’re stuck with the bill. And if you can’t repay the loan you get stuck with then a big tax bill for the early distribution. Talk about making a bad financial situation even worse. Borrow from your 401k and you are at the mercy of your employment.
Makes you look like you are chasing the Jones’s
If you can’t live within your means and need take out a 401k loan for anything other than an absolute financial crisis, what does that say about your character and spending habits? This is a huge wake-up call. Are you managing your money well? Are you keeping track of costs? These are questions you need to ask yourself if you find yourself borrowing from your 401k for frivolous purchases. Is that LED TV or kitchen remodel really worth the sacrifice of potentially a hundred thousand extra dollars in retirement?
Don’t listen to Nike, just DON’T do it!
Look, is it really worth it? There are plenty of sources of income and savings. You could even open up a zero interest credit card if you needed a short-term influx of cash. Sacrificing future gains to make a purchase today is not wise and I highly advise against it. Instead, look at your lifestyle and evaluate your choices and decisions. Are you making bad ones? If so, seek out help. You will be glad you did. If you want to be living on a beach at 65, you will NOT tap into your 401k account.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
