- 1 Are 401(k) Loans Bad For Your Retirement Future?
Are 401(k) Loans Bad For Your Retirement Future?
In theory, saving money in your 401 K should be something that is easy to do and requires very little thought beyond the setup phase. Set it, forget it, retire wealthy, amirite?? Well, unfortunately life is not as simple as any living human knows.
It is very hard not to pay attention to a significant balance in a retirement plan. Whether it’s big fluctuations in the market that has you watching your balances or significant unexpected economic hardships that make you want to break the piggy bank, the fact that you can get access to retirement savings funds in a 401 k can produce some serious temptation.
On the face of it, taking a loan from a 401 (k) can seem like a logical thing to do. It can be rationalized by saying “Hey, I am paying 6% interest to myself! What’s better than that!”
Unfortunately, the reality is that most people who take loans against their 401 k plans will lose in the long run.
Here are 5 reasons this is the case:
1. You Want Tax on Top of Those Taxes?
As explained in the video below, when you take out a loan from your 401 k plan, you, in effect, are paying taxes on your retirement funds twice. Why? Because you pay the loan back with after-tax dollars AND you are taxed once you take the funds out at retirement.
This is a serious hidden drag on the amount of money you can have available to you in your retirement years. Before taking that loan ask yourself: Am I ok with paying taxes twice on this money?
Or even better, would I take out a loan at 20% interest to solve my problem? Most would say “Hell No!” to that question. Well, you will be paying effectively 28% tax on that money which is basically equivalent to paying a 28% interest rate just to get back to where you would have been before.
2. Hey, Yeahhh..Let Me Get Back…*click*
Most people who take loans against their retirement plans NEVER PAY IT BACK fully. This is because you usually have one to five years to pay the loan back, and nowadays, who stays at their job for five years or more?
Very few people!
So when you leave your job you will be asked to pay the whole balance back or be hit with penalties and fees. So you will be taxed and fee’d to death at tax time for that money. A serious drag waiting to happen.
3. Why Did The Nest Egg Stop Growing?
Most people who take loans stop adding to their 401 k balance. This is because the new focus becomes paying the loan back! It still FEELS like you are contributing to the retirement account because you are paying some money into it, but you are not adding new investment dollars so the overall pie stops growing until you pay back the loan.
This is a potentially 5 year waste of compounding money growth. If you study compounding you will realize that the 5 years at the end of a 30-year investment cycle can mean the difference between retiring to a wealthy beach lifestyle and retiring while still needing a part-time job to make ends meet. Yes, it’s that serious!
4. If You’re Struggling Financially, This Ain’t Gonna Save You
If your financial situation deteriorates further, say through poor financial decision-making or events such as getting fired, having an outstanding 401 (k) loan adds two additional burdens. First, is the aforementioned taxes and fees coming due. Second, is that if you really hit skid row, you have already eaten part of the nest egg that could save you from complete financial disaster.
Avoiding complete financial disaster (like the loss of a home while looking for employment) could be a time to break the piggy bank. But if the bank is already broken into, what will you do??
5. So You Made A Series Of Bad Choices, What Do You Think The Next One Will Be?
Taking a loan out of your retirement plan is a huge red flag that suggests you don’t have your financial house in order and are possibly living beyond your means.
According to Investopedia needing a 401 k loan basically means you are just looking for another loan in order to spend more than you are making or have saved for a particular item or situation. In this case, this loan is seemingly more harmless than say a credit card or home equity line of credit, but the end result is still the same: Your Financial Ruin…
The video below can provide another viewpoint for a person considering taking a loan against their future retirement income.
So what do you think? Is there ever a good reason to take out a 401 K loan or are they all bad? Comment below or on our Facebook page!