6/29/2011 4:31 PM ET|
When it's OK to raid your 401k
More workers are tapping their retirement savings. And in some cases, it's a smart move (though it usually isn't). Before you do it, be aware of the serious drawbacks.
When your banker says no, your 401k says yes.
That is what many employees nationwide seem to think. Publicly traded companies recently have been disclosing how much their workers have borrowed from their retirement accounts -- and loans from 401k's are way up.
In a society already drunk on debt and an economy struggling to recover, people are even hocking their own retirement funds. Most of them are making a mistake.
But, crazy though it might seem, there is a case to be made for borrowing from your 401k account, at least in certain circumstances.
As of Dec. 31, at the retailer Target (TGT, news), total borrowings by employees from their 401k's were up 23% over the year before; at grocery chain Whole Foods Market (WFM, news), 34%; at the homebuilder Pultegroup (PHM, news), 51%; and at Heritage Financial (HFWA, news) a community-bank holding company in Olympia, Wash., 98%.
Altogether, according to retirement analyst Pamela Hess at Aon Hewitt, a consulting firm, 28% of participating workers had borrowed from their 401k's as of the end of 2010, up from 26% in 2009 and an average of around 22% earlier in the decade.
It isn't just lower-income workers who are taking these loans. According to Aon Hewitt, 23% of employees earning between $80,000 and $100,000 have borrowed from their 401k's -- along with 16% of those earning at least $100,000, up from 13% in 2005.
Traditionally, financial advisers have admonished workers never to borrow from a 401k account. That partly is because the money you invest in your 401k is sheltered from income tax, while you must use after-tax dollars to pay back whatever you borrow from the 401k.
The biggest risk: If you leave your job, you must promptly pay off any 401k loan -- usually within 60 days -- or you will owe ordinary-income tax on the remaining principal amount, plus a 10% penalty.
While about 15% of 401k loan balances tend to go into default, at least 75% of the workers who leave their jobs with a 401k loan outstanding end up defaulting, estimates Brigitte Madrian, an economist at the John F. Kennedy School of Government at Harvard University.
One of the most dangerous temptations: There are generally no restrictions on what you can use a 401k loan for. Some 22% of borrowers use the money to pay for college or medical expenses, and 39% use it to consolidate or pay off higher-cost debt, according to research by Stephen Utkus, the director of the Vanguard Center for Retirement Research.
But there is nothing to stop you from spending it on a binge in Cancún, a week at Canyon Ranch spa in Arizona or a pedigreed Tibetan mastiff with a diamond-studded collar.
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What is the deal with the government ?
Let people cash their 401k without penalty to pay bills and stimulate the economy.
Get these homes bought and sold sure would help.
Forced with retirement after being laid off....
I took money from my 401k to pay off my house and other bills...
I knew we would be living on reduced income..so took steps
to ease the pain...lol Dont think that many Americans go blow
their savings on new cars and such, in this day and time...?
I took a loan for the 1st half of my 401k balance, then cashed in with penalty on the rest. The reason was to buy a HUD house for an unbelievably low price and now I have no mortgage. In 5 years the loan is paid and I will have 1/2 back in the account plus interest. Factor in the monthly payment I am not making, and the mortgage interest being saved, I think using my 401k in this manner was the best move I ever made. So I agree with gordo, people cashing in right now are likely putting it to good use. I think the "toy" frenzy popped with the bubble.
I love it when financial advisors admonish people who do this becuase you are paying the loan back in after tax dollars. Last time I checked, the Federal gov't was going to tax you on those $$ REGARDLESS OF WHAT YOU DO WITH THEM. You've already paid the taxes - that is a mute point. If you can manage this and deal with the repayment risk, a 401k loan is just another tool in the toolbox. If you're not very skilled at managing your money, then yes - a 401k loan is probably a bad idea. But the reason financial advisors and fund managers hate 401k loans is that when they're paid commissions on a %-of-assets basis, which is common, they don't collect any commission on 401k loan balances. They want your money invested in their mutual funds.
I've read many of these '401K loan/withdrawal' articles and I don't think I've seen one yet that factors in age, the amount in the 401K, and whether you have other retirement funding (besides SS). I'm 47, I've contributed a minimum of 6% to my 401K my whole career (often more), received matching funds, and - most importantly - got it out of stocks prior to The Great Recession' and back it back in to stocks (my company stock) in near the bottom (and did VERY well). I'm also fortunate in that my employer of 25 years has a pension plan. I also have no debt, except for my mortgage.
So yes, I took a $40K loan from my 401K to buy a toy - because you only live once. Should I lose my job, I'll simply sell the toy (at a loss of course) or cash out other post-tax investments to pay it back and avoid the penalty and taxes.
I lost my job of 14 years, rec'd NO unemployment, made too much for ANY kind of Federal or State Aid to qualify for help and needed to pay the rent and eat. I ended up liquidating my 401k of "modest" value just in trying to live until I could get a full time job that I now am making 30% of what I was originally making. Now I've got to file a bankruptcy because I don't have the money to pay the penalties and income taxes.
All I can say is THANK GOD I had the forethought to do it while I was working, or I would have been homeless and on the streets.
Seriously, what other options were there?
Please let me know if you have any ideas, and I'll jump into my WAY BACK machine and do it differently.
I follow my 401K like a hawk, invest a third in mutuals, & almost 2/3 rd's in individual stocks. My company let us set up our own SDBA ( self directed brokerage account) in our 401k plan a year & a half ago. My own due diligence & learning the markets, has helped my 401k get back a 98k loss in the big whammee of 98. I had to take out 401k loans, due to medical reasons, as I could not pull in the kind of cash I used to. Being single also helps, although another income may have changed the fact of borrowing against my 401k. I had taken out around 35 k, before the crash, so in essence, I firmly know I would have lost much more. That interest was around 8% at the time, so in essence, I paid myself an 8% return, while the market was sinking like the titanic.
Sometimes, when life deals you a bad hand, you do what needs to be done to survive the current crisis. One loan is paid off now, & the second around 11k is at 3.25% interest. By buying into some top quality stocks in my 401k sdba, I was able to post a 24.4% return last year. Not bad for doing my own research & buying quality stocks on the dips. Of course big dividend stocks increase those returns, & I reinvest them for more shares. If you need the cash quickly, or to make ends meet for the time being, then do it, but invest it wisely. A 3.25% loan rate against a crazy 39% bank rip off cc rate...kind of a no brainer. Pay the card off, tear it up, & use cash. I dumped all my cc's almost 2 years ago, & strictly live on a cash basis. It gets easier after awhile, & makes you think about what "you really need".
Educate yourself, don't pay advisor commisions, buy some quilty stocks with great dividends..(reinvest those dividends to buy more of the same stock), & your 401k will cruise great over the long run. Although I am not back to pre 98 crash, I am edging closer, as well as the loan gets smaller every month, which in turn makes my 401k bigger, & if invested right will prosper in the future.
Just don't blow it on "things". If your going to do it, make it work for you for the current time, & the long run.
On the flip side if you get lucky and end up borrowing it during a down market it can end up being a bigger advantage then they are stating.
The whole idea of leaving it is because you can't predict the market and it's a long term investment. If you could predict it well enough to know when to borrow then you should just be investing and not need the money in the first place.
I stand with the leave it in there crowd.
I made the "mistake" of taking a 10G loan against my 401K back in 2004 to pay off credit card debt. The loan is paid back but I can see the "cumulative" effect of that mistake in the balance of the 401K. I should have let the 401 be and paid off the credit card with planned dedication because the loan actually cost me more in the long run.
Had to continue paying my bills,somebody forgot to mention that when un-employment runs out~and the is only little money coming in~It's OK!~Sucks that there is that 30% penalty~We or atleast some of us out here could get a job that pays worth a damn~we could let it be~
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