Updated: Aug 1, 2019
Should I borrow against my 401(K)?
If you’re strapped for cash, for whatever reason, you may be tempted to take a loan out against your 401(K). Everybody tells you that’s the way to go, because you’ll be paying yourself back with interest!! Woo hooo!! What a deal, right?
Well, no, not so much.
Borrowing from your 401(K) is a really really bad idea, for several reasons.
1). That interest you’re gonna pay yourself? It’s probably 6%, or thereabouts. At least that’s been the traditional rate. So what you’re doing is unplugging investments that are making 8 to 12% or better (or should be), in order to pay yourself back 6%. Not smart.
2). You’re not really paying yourself interest anyway. It’s all your money to begin with. You don’t GAIN interest unless it’s coming from somewhere besides your own pocket.
3). You are derailing your long term future by largely nullifying all the hard work you put in to create those investments. Your retirement isn’t really funded primarily by your contributions, it’s funded by the GROWTH of those contributions over the years. (That’s why a Roth 401(K) or Roth IRA is such a great thing....because it doesn’t tax the GROWTH of your retirement contributions, and that’s by far the biggest portion of your retirement account when you reach retirement age.) Taking out a loan like this, like I said above, unplugs the engine of growth that you need to create a comfortable retirement nest egg.
4). You may think you’ll just pay extra payments every month to pay it back really really fast. Well, it doesn’t work that way with a 401(K) loan. You are not allowed to pay extra payments every month. It’s either pay the stipulated amount each month (through payroll deductions) for the entire term of the loan, OR you pay it back all in one lump sum.
Now, if you’ve already gone and taken out a 401(K) loan, I DO hope you take this to heart and save up like crazy to pay that lump sum back, like by yesterday! But alas, most people don’t have that kind of discipline. If they did, they wouldn’t have taken out a loan to begin with. Nevertheless, it’s not too late to change your mindset. Go crazy, save up and pay it back, pronto!!!
5). And.....the single most important reason to NEVER EVER, under any circumstances, borrow against your 401(K), is this:
WHEN you leave your job (and you WILL leave your job, when you find a new job, when they fire you, or when you die), that loan becomes DUE in FULL within 60 days of your leaving. If you don’t pay it back within 60 days, it becomes an early withdrawal, and if you are younger than 59½, you will pay not only your regular tax rate on that money, but also an additional 10% penalty on it. So, you’ll lose somewhere between 30% to 45% of that money to the government.
If you’re thinking about a 401(K) loan, there’s a good chance you have loads of other debt as well. People tend to turn to this kind of loan as a last resort, perhaps instinctively knowing it’s not a good idea, or because they think it “doesn’t count” somehow (the old “I’m paying myself back” thing). Often people will borrow against their 401(K) in order to pay off other debts.
But YOU CAN’T BORROW YOUR WAY OUT OF DEBT!
Proverbs 22:7 says that the borrower is slave to the lender. Don’t put yourself into slavery! Get on a written budget, live on less than you make, make saving a habit, and get OUT of debt!! I can help you with all of those things. Schedule a free consultation and let’s put a plan together.