GREENSBORO, NC -- 2WTK gets emails and calls from viewers who are surprised by the amount of money they are taxed or charged when they borrow from their 401k. We asked Certified Financial Planner Matt Logan to give us options on the real expenses of taking a loan against your retirement and when it might work for you.
What Are The Top Reasons For Borrowing From Retirement Savings?
I did some research and I found this interesting survey from TIAA-CREF from 2014. According to the study, the top reason for borrowing from retirement savings is to pay off debt. As you know from previous interviews, I am not a huge fan of debt. It can be a crippling stressor on households. That being said, there is a huge reason that you may not want to access these funds to pay off debt. In most cases, your 401k or pension plans are exempt from creditors. This means that if you were to have to declare bankruptcy, these funds are not treated like your bank account. They are not accessible to your creditors and would be protected. Please think twice before using your 401k funds to pay off debt.
Matt's Top Reasons Not To Take A 401k Loan
Losing job or changing jobs: If you have any reason to suspect you may lose your job or leave your employer. When filling out the loan paperwork, most people don't read the part that says for most plans that loans must be paid off in entirety within 90 days of your separation of service or it will be treated as a distribution. If you think you may be losing your job or changing jobs and you would not be able to come up with that money, you will be issued a 1099 for the loan balance in most cases. If not paid, a 10% penalty is charged in most cases for those under age 59 1/2. On top of income taxes.
Opportunity costs: Many times a loan on a 401k will have a lower interest rate than the funds would have earned if left in the plan. If you were to take a loan and be paying back that interest rate, you could be losing out on the gains that those funds would have been making if they were left invested. This could result in a lower amount of funds when you retire.
You have other options for taking these funds: If you are taking these funds because they appear to be a better rate than a home equity line, it is probably best to look a little closer. Many times your mortgage debt is deductible and when you include that fact in the calculation, it can make the home equity line much more attractive.
Luxury items: Are you taking funds to buy that sports car you have always wanted, to pay for an overly extravagant wedding, a boat or some other expense that is not a necessity? Take a moment to think these things through. You most probably should not consider a 401k loan for this. Would you need the funds to have a higher down payment for a larger home? Maybe you are buying too large of a home and might want to reconsider.
A child's education: You can take loans out for education but you cannot take loans out to retire. You do not owe your child an education at the expense of your own retirement. If your child is at a school and needs help, take out the loans. You may actually help your child become more financially savvy through this process and possibly even speed up their graduation.
Matt's Top Reasons To Take A 401k Loan
You can pay the loan back quickly: If you are taking a loan that you will be able to pay back in a short amount of time, such as a year or less, your risks are lowered as to the effects it will have on your long term retirement success.
You have credit card debt with high interest rates: If you have credit card debt with very high interest rates and you are otherwise financially healthy and you can pay it off in a short time frame, this would make sense in some cases. It is not ideal, but it could make sense. If you are close to bankruptcy, you are best not withdrawing these funds because they are protected from creditors.
So, to answer the viewers question, I do not think it is in your best interest to take a loan from your 401k to pay for a vacation in most cases. Please put your future needs in retirement higher than your current wants to go on a nice vacation. Maybe look at other ways to fund the vacation or even less expensive vacations.
DISCLAIMER: Matt Logan Inc is an independent firm with Securities offered through Summit Brokerage Services, Inc., Member FINRA, SIPC. Advisory services offered through Summit Financial Group Inc., a Registered Investment Advisor. Summit Brokerage Services, Inc., its affiliates and Matt Logan Inc. do not give tax or legal advice. You should consult an experienced professional regarding the tax consequences of a specific transaction. These are the views of Matt Logan Inc, and not necessarily those of Summit Brokerage Services, Inc. and any of its affiliates and should not be construed as investment advice.