Borrowing from your 401K?!?!

STOPPPPPP!!!!  Dont do it!!!  Those are the words that were screaming in my head when She asked me that question.  The question that made me realize my help was needed on a broader scale than what I had imagined.  The question that made me realize that not everyone has the time or desire to read Money magazine, the financial sections of newspapers, read all about early retirement on countless FI blogs, and listen to Motley Fool podcasts, .  WHAT A DRAG!  😉

SO, here we were cruising at altitude and chatting about 401K options.  A nice conversation between two people who met 30 minutes prior.  That’s how it is in my world.  We get on a plane, strap into our seats, and peoples deepest darkest secrets come spilling out.  It’s like 2:30 am at a bar – the night isn’t ending as planned and so it takes a devastating turn towards Disasterville with a round of shots followed by a 1 hour binge cry on the last man in your life who so obviously ruined everything.  No, I haven’t been that girl but I have coaxed quite a few of my friends into cabs at 3 am.  In my profession,  I think we do this to ignore the subconscious thought to the back of our heads flight after flight – what if this is the one?  The flight that goes awry?  These therapy sessions are needed like a last minute confessional.  Rid your body and mind of what has been bothering you so we can go into the next phase unencumbered.  This girl, She, was encumbered with the thought of taking a 401k loan…seriously, deep and dark shit!

Once the screaming reflex quieted in my head, I was able to calmly relay why the thought of a 401k loan is a terrible idea.  Besides the obvious fact that a retirement fund is for RETIREMENT, there are other factors that seem to get lost in the idea that” it’s your money and you can spend it how you please”.  While that may be true, in some part, there are other factors to consider.

First off, do you have a traditional 401k or Roth 401k.  Different strokes for different folks 401k’s.  Let’s stick with the traditional 401k for this conversation.

The second issue is how much are you looking to borrow?  The IRS sets some limits as to what you can take from “your” money.  Here it is, straight from the horses mouth…

The maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000, whichever is less.”

For example, if you have $153,627.25 (just a random possibly personal number) and want to take out the max loan, you may only take out $50k.  If you have 40k in your plan, the max you can take out is 20k.  Not all companies allow 401k loans (ours unfortunately does) and the funds you are taking out must be vested (our vesting period is 5 years).  We can go on and on about more ins and outs but it is best to contact your companies benefits department directly and/or the IRS for more exact terms and information.  

Now before you get excited, remember that this is only a LOAN!!  It must be paid back in a specific amount of time and loan payments are not contributions…which brings me to the most important part of this equations – compound interest, or lack thereof.  

The 3rd reason and MY #1 reason to sway a doe eyed flight attendant away from this easy to reach bag of cash, is what they would be losing as apposed to gaining.  Sure, 20k seems like a quick paycheck for whatever nonsense you’re looking to purchase, but is losing $$131,000 worth it???  Let’s look at some quick math done by the fine folks at Money magazine circa August 2014 (sourcing Wealth Management Systems).  

There was a reason I cut this out and added it to my folder of grand financial ideas – you cant argue with the numbers!!  If you can keep yourself from “needing” this 20k now, in 20 years (assuming a beginning balance of 250k) you will have $1,528,000!!  On the other hand, if you decide to take the easy route of borrowing the 20k AND no longer adding extra contributions to your account in favor of paying back your loan, you will only have $1397000 at the end of the 20 years.  :((  Major saddy face.  That means that your 20k, with the magical help of compound interest, was able to grow and snowball simply because it was still accounted for.  Your little money soldiers were out doing their job and recruiting more bucks!!

Now, I am not saying there is never a good reason to tap into your 401k.  There are.  Health issues being a major one or perhaps loss of a job without an emergency fund.  For all other reasons, make sure you have done your due diligence and exhausted all other options before doing so.  Equity lines of credit, personal loans from family and friends, another job to add income… and, in the end, ask yourself if this purchase is really necessary.  If it is for a shiny new car, a bigger grander house, or a new set of boobs (we see that a lot in my industry! ;)) then it is possible you may want to reevaluate the difference between wants and needs.  Is keeping up with the Kardashians really worth $131,000??  After my spelling it out, She did’t think so.

** SOOOO, have you ever taken a 401k loan?  No judgement!!  Feel free to leave a comment and let us know how it turned out for you.  The more real life experience we hear the better for anyone to make a qualified decision should they be tempted.  🙂 **

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