Thinking About 401k Loans? Don’t Do It
The purpose of 401k investing is to get you financially ready to retire at the lifestyle level that you have always dreamed of, right? When you finally reach the age that you want to retire due to health issues, work related stress, job dissatisfaction or because your family and friends are retiring, do you really want to be forced to continue working? Do you honestly want “insufficient funds in your personal retirement account” to be the reason retirement is the impossible dream? No of course not, you just want out.
Well, you could find yourself in that financial situation if you are in the habit of taking out 401k loans. All a 401k loan does is deplete your retirement reserves, and basically defeat the entire purpose of retirement investing. Your 401k account has a specific purpose, financial preparation for your perfect retirement, period. If you are in the habit of spending money invested in your 401k, how will you support yourself when you eventually do retire?
Your 401k account is not a revolving savings account. If you want an account to dip into whenever you need money to buy something, open a checking account. The plain fact is, the only money that will be waiting for you on retirement day will be the money that you sent ahead. Remind yourself of that fact every time you feel the urge to take out a 401k loan. There are many reasons why 401k loans are financially unhealthy, a few reasons why a 401k loan might be beneficial and 3 alternative sources of money if you are really in a pinch.
Top Reasons To Stop And Think Before Taking A 401k Loan
Say Buh-Bye To Growth
When most people place their money into an investment, they anticipate investment growth. Don’t you?
Well, when you borrow against the balance of your 401k account you eliminate the most important opportunity for investment growth, the power of compounding. Any growth opportunity that may exist is greatly reduced by a 401k loan. Loans drain your account balance; after a loan there is less money left for the power of compounding to work with. Compounding works best on untouched account balances. Compounding simply put is just growth upon growth. If you keep depleting your account balance by borrowing against it, the inevitable result is insignificant growth.
Taxes & Penalties, You Bet
The IRS is tough on unpaid 401k loans.
If you do not repay a 401k loan, regardless of the reason, the IRS considers the loan to be in default. So the IRS takes that opportunity to tax you on the outstanding loan balance. In addition, if you are under age 59 1/2 and do not repay your loan, you are not only taxed but also subject to a 10% withdrawal penalty on the outstanding loan balance. If you unexpectedly lose your job, you will have to repay the outstanding loan within 60 days, otherwise it is considered a default. So you can see how taxes and penalities on unpaid 401k loans completely undermine your efforts for trying to save for retirement.
401k loans not only rob you of investment growth but they can also become a big old hassle. Payment terms on 401k loans are usually not as flexible as other loans. The terms of most 401k loans is five years and that is non-negotiable. A 40k loan cannot be rolled over to an IRA, therefore it must be repaid if you leave a job. Interest on the loan is not tax-deductible.
There May Be A Good Spot
The only good thing about a 401k loan is the convenience of it all. They are easy to get started and administer; just filling out a few forms. Most of the time the interest rates are reasonable. You repay the loan through your payroll, again, convenient. And when you do repay the loan you are actually repaying yourself because the money goes right back into your 401k account.
Try Other Alternatives First
Before you pull the trigger and take out a loan against your 401k balance, you may first consider some other alternatives. First, you could stop your current 401k contributions. The money you save from that action can be used for whatever financial need the loan was intended for. Second, you could consider other sources of funds. There are less expensive ways to borrow money; alternatives that are not subject to taxes and high penalties. And third, you could change your current spending habits by cutting back on your spending. It’s not what you make but what you keep that will put you ahead financially. Change your current spending habits, save money, avoid borrowing against your 401k account; in the long run you will be glad you did.
It’s All About Your Future
What Is Best For Your Future
Your 401k retirement investments are for financing your future and no one cares as much about your future as you do. If you do not prepare financially for your retirement, who will? If you do not make a commitment to make regular contributions to your 401k account and avoid borrowing from the same account, who will? A 401k loan takes its toll on your long-term retirement planning. You are cheating yourself in the long run by borrowing against your future source of income.
Your 401k investment will be your strongest source of funds at your retirement. Social security is a weak source of retirement funds, and getting weaker as years go by. So if social security is not available at all by the time you retire, your 401k account may be your only retirement money. Protect your 401k account, value it, do not abuse it by borrowing against it, you just hurt yourself that way. If you manage your 401k account properly and resist all temptations to take out 401k loans you can have the dream retirement that you have been planning for all of your working years. Make your retirement dream a financial priority; if you don’t, who will?