Borrowing from your 401k
A new report suggests that more and more Americans are borrowing from their 401(k)s to pay their regular bills but very few of them are putting any money back. This study, entitled “401(k) Loan Defaults: How Big Is the Leakage and What Can Policymakers do to Preserve Americans' Nest Eggs?” estimates that defaults on these 401(k) loans could total as much as $37 billion in the coming year. This is a huge increase from 2007 when loan defaults totaled approximately $665 million.
Usually individuals with 401(k) plans borrow from them as an absolute last resort. But the recession which started a few years ago and from which the U.S. economy is still recovering caused a lot of people to borrow from these retirement accounts to maintain an even lesser standard of living.
Most financial experts agree that borrowing from your 401(k) is almost always a bad idea. The only exceptions might be if you are facing foreclosure or bankruptcy and even then you should carefully consider the financial consequences of borrowing against your 401(k).
Here are some very good reasons why most financial advisors strongly suggest that you not borrow from your 401(k) except in the direst financial situations:
Your 401(k) is tied to your employment. Considering the current instability of the job market and the overall sluggish economic conditions, the odds are fairly high that you will leave your present employer at some point in time. The reality is that it may or may not be your choice to leave. No matter what the circumstances are, you will be required to repay the loan.
The repayment time is short. When you leave your current employer, you are allowed 60 days to repay your loan. If you do not repay it within this time period, the IRS will consider the remaining amount due as a withdrawal (distribution). Unless you are at least 59 ½ years old, you will be taxed at your current rate with an additional 10% early withdrawal penalty.
You pay double taxes. The contributions which you make to your standard 401(k) are in pre-tax dollars. However you are using after-tax dollars when you repay a loan. When you retire, you will be required to pay taxes on the distributions again. Also the interest which you pay on the loan is not tax deductible, even if you are using the funds to purchase a primary residence.
Some 401(k) plans will not allow you to contribute while your loan is outstanding. Some companies actually force you to stop contributing until your loan is fully paid off. Many people stop contributing on their own because they need the extra funds to make the loan payments. No matter how you look at it, you are losing a considerable amount of dollars over the course of your loan.
Some plans charge a fee for loans. Depending on the fee schedule, this is just more money lost.
You are borrowing against your future. Your 401(k) is designed to help fund your retirement. Any time you borrow against it, you are hurting your overall 401(k) value and putting your future at risk.
It can be a sign that you are living beyond your means. If maintaining your current lifestyle is forcing you to consider borrowing from your 401(k), this is a serious red flag that you are probably living well beyond your means. This should serve as a wake-up call to honestly evaluate your spending habits and make cuts wherever possible.
In all matters financial, it is always smart to stop and think before making a hasty (and many times regrettable) decision. Before risky your future security, take the time to re-evaluate your spending habits and overall lifestyle. Consider ways to cut back on your living expenses. By making smart financial decisions today, you will be helping to insure that you are able to enjoy a comfortable retirement with a sizeable nest egg.