3 Reasons You Should Never Borrow From Your 401k

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by Jason Cabler on 12:01 am · 13 comments

in debt,desperation,money problems,Uncategorized

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Have you ever dipped into your 401k when you needed money?  Maybe it was to pay off an emergency expense, a nagging debt, to buy a house, or some other reason that sounded good at the time.

If so, how’d that work out for you?

 

A 401k Withdrawal Has Consequences

borrow from your 401kWithdrawing money from your 401k account to meet an immediate want or need in your life can be disastrous to your future.  Even if you do it for a responsible reason, it still has consequences that can damage you financially for the rest of your life.

 

2 Ways to Take Money Out of Your 401k

Let’s take a look at the two ways you can take money out of your 401k retirement account, and the consequences of each:

  • 401k Withdrawal-  Taking money out of a retirement account means you’ll take a huge immediate hit financially.  Not only will you have to pay your usual tax rate on the withdrawal, you’ll also have to pay a 10% penalty on top of that.  This means you end up losing as much as 35-50% of the money you take out to taxes and penalties.  You can get a more detailed explanation here.
  • 401k Loan-  You can also take money out as a loan.  If you take out a loan from your 401k, you have to pay it back with interest.  You don’t have to pay taxes or a penalties on the loan (that’s good), but there are several problems that you’ll need to think about before you do this.

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401k Loans Have Their Drawbacks

There are 3 reasons why taking a loan from your 401k can spell disaster for your future:

  • It Hurts Long Term Investment Growth-  Even though you’re paying back the loan with interest, you’re more likely to get a better return in a more traditional investment such as a mutual fund.  Plus, in a traditional investment, the interest is being paid to you by someone else and not coming out of your own pocket.  This could cost you tens to hundreds of thousands of dollars of investment growth over your lifetime.
  • You’ll Do It More Than Once-  People who take loans from their 401k tend to do it more than once.  It can become a habit, thus compounding the problem of diminished returns I mentioned above.
  • You Contribute Less-  When you’re in the middle of paying off a 401k loan, you will have a tendency to make fewer contributions to your 401k, if you make any at all.  Again, this hurts the long term growth prospects of your account and will cost you a ton of money over the long term.

 

3 Reasons You Should Never Borrow From Your 401k

Borrowing From Your Future

Overall, borrowing or withdrawing money from your 401k account can be very detrimental to your present, and especially your future.  I’ve always told people that borrowing from any source will always make you poorer.  But when you borrow or withdraw from your 401k or other retirement account, it sets you up for a double whammy of lost investment growth that in my opinion is just not worth it.

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My Recommendation

If you must borrow money, don’t sabotage your 401k to do it.  Even better, learn to set yourself up for never having to borrow again by putting together a solid plan for getting out of debt and do what it takes to make that happen.

When you take complete control over your finances instead of letting your finances control you, then you start winning financially.

Your future will thank you!

Question:  Have you ever taken money out of your 401k to take care of an immediate need?  Leave a comment and tell me your experience.

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Resources:

Why You’re in Debt and What You Can Do About It

Drunken Sailors and 401k’s

Talk Yourself Out of Debt- How to Create a New Script

Introducing the CFF Online Get Out of Debt Course!

The Ultimate Guide to Understanding Your 401k

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  • http://www.debtroundup.com/ Grayson @ Debt Roundup

    I try to keep my 401k out of sight and out of mind. I do check it out every once in a while to make sure I am allocated properly, but other than that, I don’t touch it or look at it. 401k loans scare me and I would only use one if I was about to lose everything.

    • http://www.CFinancialFreedom.com Dr. Jason Cabler

      Great strategy. As Ron Popeil used to say “just set it, and forget it”

      • http://www.debtroundup.com/ Grayson @ Debt Roundup

        Very true. Never would have thought to compare a rotisserie oven to my 401k strategy, but why not!

        • http://www.CFinancialFreedom.com Dr. Jason Cabler

          I see a new article in the making: “Rotisserie Chicken and 401k’s”

          • http://www.debtroundup.com/ Grayson @ Debt Roundup

            Haha, awesome topic and great title. That would bring some attention.

  • Travis Pizel

    We currently have a 401K loan…and while I wish we didn’t have to have done it, it did work out pretty well for us. It cleared hundreds of dollars a month in our budget in payment savings because the interest rate was much lower. Yes, it did hurt the long term growth of our funds…but when you’re struggling, it may be an option rather than be in a continuous state of struggle.

    • http://www.CFinancialFreedom.com Dr. Jason Cabler

      Yeah, it sucks having to do that. You have to weigh out your options and understand the effects that taking out that loan has on your future. Knowing you and your story, I’m sure you thought about that before you did it.

      The good thing is that you are now disciplined, getting everything paid, and you’ve made up your mind you’re never going down the debt road again.

      Some people just see a 401k as a stash of money to use when they have an emergency or things get tight. I suspect you don’t view it that way.

      • jim

        Ok, I get the gist of don’t touch your 401(k), but I have a question. When we get our mortgage to $50K or under wouldn’t it make sense to tap my spouse’s 401(a) account for $50K to finish the mortgage off? We’d be paying it back to her account at 4% and be living with the peace of mind that our mortgage was GONE. She’s not in jeopardy of losing her job – she’s been working (excelling) there for 27 years. So I’m not seeing the downside of doing that and we’re getting really, really close to having this mortgage at $50K.
        Because I read these blogs, my gut is telling me to not do that – but my brain is arguing with my gut and telling me that we should do that.
        Any and all comments/insights would be appreciated – especially from those of you who are inclined to tell me this is a hair brained idea. Thanks.

        • jim

          p.s. I forgot to add the MOST important reason we’d like to tap my spouse’s 401(a) for $50K when that’s what our mortgage balance is and this is it – we lost our asses twice in the market – BAD – even tho our portfolios were balanced, rebalanced and balanced again. We could have had this house paid for in full twice already if we had tapped her account. We think the market is going to crash again soon and rather than see that $ just up and disappear, we’d like to take it out, pay off our house and then go with the flow.

          • http://www.CFinancialFreedom.com Dr. Jason Cabler

            Paying off the mortgage with that money and then paying it back at 4% probably wouldn’t gain you much. You may have the peace of mind of not having a mortgage, but you still have a debt burden. You’re just trading one type of debt for another. If it was me, I’d continue paying off the mortgage, and let the money in the 401a make money.

            I know you’re frustrated with losing money in the market, but most everybody got their butts handed to them a couple of times in the last decade or so. I’m not an investment adviser, so I don’t feel comfortable giving specific investment advice.

            You may want to read up on what it is you’re investing in and be sure that it makes sense. If these investments were recommended to you by an investment adviser that’s paid on commission, you should be especially wary.