Still, if you have urgent legitimate spending needs or high-cost debt you want to erase, tapping your 401k might make sense. Although a few retirement plans charge interest rates of 10% or more on loans, the most common rate is currently just 4.25% -- compared with 11% on personal bank loans and 13.4% on credit cards, according to the Federal Reserve.
Even Utkus has borrowed from his 401k. "I've used it for cars, I've used it for housing improvements," he says.
From your portfolio's perspective, taking out a 401k loan is like adding a bond position: You are plunking down a chunk of cash in order to receive a steady stream of interest income. The difference is that the interest comes out of your paycheck, rather than from the issuer of the bond.
'Take only the minimum'
Borrowing from your 401k at 4.25% to pay down credit card debt at 13.4% gives you a return of more than 9%, points out Hess of Aon Hewitt, even if stocks or bonds go down in value. That return is virtually risk-free, unless you leave your job before you have paid off the loan.
Say you borrow $10,000 from your 401k at 4.25% for a one-year loan to pay down a credit card balance carrying an interest rate of 13.4%. If you had left the money intact in your 401k, you might have earned a 5% return on a 50/50 mix of stock and bond funds, giving you $10,500 after a year. With the loan, your interest payments go back into your 401k, so when it matures in a year you will have returned $10,425 to yourself.
In exchange, you have not only eliminated $1,340 in credit-card interest charges but also prevented them from continuing to mushroom. Here, taxes don't matter, since paying off either loan requires after-tax dollars.
If this is making sense to you, please remember: Debt is always risky. And this debt carries the extra risk that you could have to pay it off at the very time when you aren't earning a salary. If you leave or lose your job, you must have a feasible means of immediately paying off the loan.
"Take only the minimum you need, not the maximum you can get," says Hess.
Your loan should fund an asset of enduring value, advises Madrian: "If you have to leave your job, you can't sell the vacation to pay off your loan." Don't take a loan of last resort to splurge at a resort.
This article was reported by Jason Zweig for The Wall Street Journal.
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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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