Don’t Make This Mistake With Your 401(k) Loans

Checking your investments is a process that evokes mixed emotions. It’s fun to see your return on investments and to estimate how much you will have in the future; however, it is also scary and stressful to think that you may not be on track with your savings plan. It may also be tempting to borrow from your 401(k). After all, it is your hard-earned money and you may need it to pay for debts or emergency expenses.

You should never borrow from your 401(k) account unless it’s really your option for emergencies. In this article, we outline why borrowing from your retirement plan is a bad idea. At the end it can leave you penniless in the future.

Compounding

Rather, loss of  interest. Borrowing money from your 401(k) plan is the same as selling off your investments. Selling off your investments puts you early at risk. You won’t see your investments perform well, because you will be pulling them before they can mature or compound.

Additionally, borrowing your retirement funds and paying them back means you will be rebuying your shares. What’s worse: you will re-buying your shares at a current price – and a higher one, too.

High Risk

Any way you slice it, borrowing from your 401(k) is a financial risk.

There are a few task risks associated with borrowing from your retirement plan. 401(k) loans have to be repaid within 5 years and – should you fail to do so – your income taxes and early withdrawal penalty will be added to your plan. Some plans also have a stipulation in place that says you cannot contribute until you have paid your loans. This means you also may not be able to contribute more later.

You will also be double taxed on your account. You’ll be repaying your debt with after-tax money but you will be taxed on these funds again when you go to withdraw them. Essentially, an early withdrawal means you will be paying twice the taxes.

Should you lose or quit your job, you will be faced with an additional risk. Your loan will be due within 90 days. If you don’t meet the deadline, the IRS will consider it taxable income.

You’re Defeating the Purpose

Your retirement fund is for just that: your retirement. You may be in dire need of this money now; however, when you’re in your late 60s and early 70s, you will regret having borrowed those funds.

There are several options for you to solve your current financial situation, and you do not want to see your hard-earned retirement fund diminished by a rash financial decision.

Interest and Fees

You will have to pay an administrative fee to maintain your account, which usually hovers right around $75, regardless of the size of your loan. So, say you borrow $1,000 from your account. Right away you will have lost roughly 7.5{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} of what you borrowed.

Interest; however, is based on prevailing market rates and will be returned to your account. The problem with the interest being returned is that you could have invested those funds for higher returns. Ultimately, paying interest will reduce the amount of money you could make.

Pay Reduction

If you borrow from your plan, you may find that you have to start repaying your loan via an automatic deduction. This is particularly problematic because your take home pay will be reduced. In some cases, your pay may be reduced by the same amount that you were originally contributing, except this time it will be taxed and you will be paying more money to return it.

Your Debt Won’t Disappear

Borrowing your retirement money to pay for another debt is exchanging debts. It is better to find an alternative means to pay for your current debts and bills than to borrow from your future.

Replacing one debt for another is a bad habit and one you should break as soon as possible. There are plenty of financial resources available to help you break the debt cycle. Speaking to a financial adviser should always be your first step when considering how to get out of debt.

In 2013, Fidelity conducted a study that found that 66{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} of the 180,000 people who took out 401(k) loans during the year took out more than one loan. Of this number, 25{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} borrowed three to four different times and 20{bc669dfb3651bb8509a96034cbe7494d3a811fc0eedf0ddccb239fb9cb737439} borrowed five times or more. Borrowing is a slippery slope for many, so finding out alternative ways to pay your debts is imperative to good financial planning.

Bottom Line: Leave Your 401(k) Alone

Retirement can be expensive, and you want to make sure you have saved enough money to cover medical expenses and living expenses in your later years when you’ll need it the most. Our blog is filled with plenty of tips and tricks to help you save for retirement and gain a financial foothold. Our financial planners and our blog is here to provide you with financial advice, news and information to help you save for retirement and your later years.

Allowing your 401(k) to grow without hindrance will be a huge asset to you later in life, particularly during your retired years. With a little creativity and the help of a good financial planner, you will be able to find alternative means of paying your debts.