Have you ever taken a loan out of your 401 k

[TammyAlphabet]

I have heard of people taking out 401K loans for plastic surgery.

 

[dvcgirl]

Clark Howard was just talking about this. 30% take out 401K loans, and two-thirds of those people default on the loan....never paying it back, thus taking the huge hit in taxes and penalty.

Also, forget that you're unplugging your investment by taking the loan, but remember that you initially got the tax deferred benefit when investing in the 401K. When you pay the 401K loan back, it's with *after-tax* dollars.

It really should only be for absolute catastrophic reasons.

As it is, 50% of workers who switch jobs never move the 401K to the new job or roll it to an IRA....they spend it.

So, it's no wonder that Amercian 401K account balances are so incredibly low.

 

[crisi]

We did last year. For all the "always a horrible idea folks"

We bought a second small house for my brother in law. He had cancer, he wouldn't be able to work, he was in grad school, and he was living in a hellish little apartment.

To do this, I was going to take out a mortgage on my own home and buy his.

Mortgage on our house was going to close later than we wanted - or indeed had targeted. Something got snafu'd in underwriting. So I was going to have a brother in law going through chemo that was homeless for a week.

I don't have six figures in liquid assets sitting around. Most of my stock right now is dividend stock that I got for a song when the market crashed - if I bought back in I wouldn't keep my income. And the vast majority of my assets are harder to get at (tax consequences on just touching 529s aren't pretty. Can't get to a deferred comp account without quitting the job) I did sell some other bonds, had some cash on hand, but I only had half a house with stuff I was willing to temporarily liquidate.

So I took out a 401k loan. Paid it back three weeks later when I had a mortgage on my house again. Paid a whole $200 in interest or something an a $95 or something processing fee. And most importantly, made my husband, brother in law, and mother in law have one less stress in their lives during a very stressful time.

Basically, the bridging load the clh2 talks about.

 

[FayeW]

Borrowing against a 401K is always a bad, bad choice. It's better to get a personal loan or even to use a credit card. Unless you're really in a mess -- like something medical or losing your house -- AND you have no other options, this isn't a good choice.

When you borrow against a 401K your investment isn't appreciating value; thus, you're missing out on earning interest. Yes, you're paying back interest to yourself, but -- depending on the market -- it may not be as much as you could've been earning. Also, you're paying the loan back with taxed dollars, and then in the future when you take the 401K money out to use it in your retirement, you'll be taxed AGAIN. You can find detailed explainations /examples on the internet to show just how expensive this is.

I'm shocked that so many people have taken out such loans. It just proves that so many Americans 1) aren't financially saavy, and 2) will do anything to prevent cutting back /economizing today.

But aren't you paying the credit card and personal loans back with after tax dollars too? Using the reasoning from a PP, if paying back the 401K with after tax dollars constitutes a "hit" of 30%, wouldn't paying a loan with a 7% interest rate with after tax dollars incur a 37% hit??? And with a loan or credit card, the interest you are paying is to somebody else, at least borrowing from your 401K means you are paying it back to yourself.

We don't have 401Ks in Canada, but I am guessing it is similar to our Registered Retirement Saving Program (RRSP). If we withdraw money from our RRSP we pay tax at the time of withdrawal, and claim it as income on our taxes. It doesn't have to be repaid as it is not a loan. There are only two circumstances when we can "borrow" money from our RRSP and that is as first time home buyers, or if you are returning to school. There is a maximum amount you are allowed to withdraw, and you have to repay within a certain number of years. If for some reason you can't make that year's repayment contribution you claim that portion only as income.

It is very common for people to use their RRSPs for their down payment. I always say to my clients "the bad news is, you have to pay it back. The good news is that you are paying it back to yourself, and in 15 yrs you will have your money back". There is no interest on the money that is repaid, but they don't get to claim the amount of their contributions that are going towards repayment as a tax break, either.

It's not always as cut and dried as saying "it's always a bad idea". Depending on the circumstances it may make perfect sense.

 

[LoveBWVVBR]

This is ALWAYS a bad idea. I've known people that have actually done it for CAR loans because they are of the mind that you are "paying yourself interest." HORRIBLE Logic. I would have to seriously be about to lose my house or life to consider this.

Not always! I took out a small loan against my 401K so we could scrape up the 5% down to purchase our first house. This was in MA in 1997, so right before the massive housing run-up. I paid the 401K loan back w/in a year. That house more than doubled in value in the 7 years that we owned it. We made over 200K on the sale. I'd say that the small 401K loan paid off a thousand times over in this case. This is why I won't generalize about taking a loan against a 401K. There are sometimes good reasons to do so. Everyone needs to weigh their individual situation and make the decision accordingly .

 

[dvcgirl]

We did last year. For all the "always a horrible idea folks"

We bought a second small house for my brother in law. He had cancer, he wouldn't be able to work, he was in grad school, and he was living in a hellish little apartment.

To do this, I was going to take out a mortgage on my own home and buy his.

Mortgage on our house was going to close later than we wanted - or indeed had targeted. Something got snafu'd in underwriting. So I was going to have a brother in law going through chemo that was homeless for a week.

I don't have six figures in liquid assets sitting around. Most of my stock right now is dividend stock that I got for a song when the market crashed - if I bought back in I wouldn't keep my income. And the vast majority of my assets are harder to get at (tax consequences on just touching 529s aren't pretty. Can't get to a deferred comp account without quitting the job) I did sell some other bonds, had some cash on hand, but I only had half a house with stuff I was willing to temporarily liquidate.

So I took out a 401k loan. Paid it back three weeks later when I had a mortgage on my house again. Paid a whole $200 in interest or something an a $95 or something processing fee. And most importantly, made my husband, brother in law, and mother in law have one less stress in their lives during a very stressful time.

Basically, the bridging load the clh2 talks about.

Yes, but what you did was a huge exception to the rule. Most people who are taking out 401K loans are doing so because of financial distress, not using it as a convenient bridge loan.

Again, two-thirds of that 30% taking those loans.....default on the loan, so that speaks for itself I think.

 

[SuzanneSLO]

Yes, but what you did was a huge exception to the rule. Most people who are taking out 401K loans are doing so because of financial distress, not using it as a convenient bridge loan.

Again, two-thirds of that 30% taking those loans.....default on the loan, so that speaks for itself I think.

But the fact that others defualt on similar loans does not tell you whether it makes sense for you personally. Using that logic, you should never take out a mortgage because other people default on them.

We took a loan from my 401(k) many years ago when my DH was starting a business. We had done all the spreadsheets for his start up costs based on him renting space and then he found a property to buy. While the total payments for the property (including the 401(k) loan) were significanlty lower than his rent would be, we had not budgeted for the additional cash down payment needed up front.

My job was very stable, so we borrowed from my 401(k). We paid off the loan and later sold the property for 3 times the original purchase price. For us, it was absolutely the right decision.

-- Suzanne

 

[dvcgirl]

But the fact that others defualt on similar loans does not tell you whether it makes sense for you personally. Using that logic, you should never take out a mortgage because other people default on them.

We took a loan from my 401(k) many years ago when my DH was starting a business. We had done all the spreadsheets for his start up costs based on him renting space and then he found a property to buy. While the total payments for the property (including the 401(k) loan) were significanlty lower than his rent would be, we had not budgeted for the additional cash down payment needed up front.

My job was very stable, so we borrowed from my 401(k). We paid off the loan and later sold the property for 3 times the original purchase price. For us, it was absolutely the right decision.

-- Suzanne

And again, you would be a very rare exception to the rule. People also start small businesses using Credit Card debt all of the time, and so...sure, you can use all sort of sources to borrow money.

But if the business goes south, and you default on the CC debt....you can file for BK protection, and in most states, your 401K is a protected asset. If your plan failed, and the business goes south, and you defaulted on your 401K loan....your money is gone, and then very often, the person needs to come up with the money to pay the IRS, because I think they only withhold 20%. And the tax rate for many ends up being closer to 40% with the penalty and tax rate factored in.

At least 80% of Americans now are responsible for their own retirement savings. Only 20% have "traditional pensions", and they're disappearing so fast it's hard to keep up with it. And we know from the Employee Benefit Research Institute who has been tracking retirement savings and 401K account balances for years and years that the numbers are abysmal.

The main reason that those balances are so low is obviously that they simply aren't adequately funded, but far too many people have used their 401Ks as ATMs....by either borrowing the funds and not paying it back, or never rolling it over to an IRA or the new company when they change jobs...and simply spending the money.

And so yes, are there exceptions to the "borrowing from your 401K rule is a bad idea"......absolutely. But they are very rare exceptions.

 

[eliza61]

Holy cow that's a LOT of people.

Loans against your 401k, in almost all instances, are a horrible, horrible, horrible idea.

There's also, in most if not all instances, restrictions on reasons for taking a loan. Last company I worked for, there were only 4 reasons you could take a loan out (school expenses, purchasing a home, 2 others that I forget). Also, if you were to ever leave the company, the loan would have been due back in full.

Really my company you can take out a loan for any reason what soever. A withdrawal has a lot of restrictions but loans are doable for any reason.

We have taken out 401K loans twice. Once I home had fire damaged so we took out the loan for remodeling. Our interest at teh time was 4% lower than any bank or credit union. The interest was paid back into my account.
The big downside was that, that chunk of change is no longer growing for you

my job was/is as stable as a job can get so it was a good decision for me.

I would use it again if it made sense for me.

 

[kanga24roos]

We have taken 2 small loans from my DH 401k both times were during medical emergencies that coincided with property tax time. We are paying it back and are not seeing it as a major problem since we are all alive and still have our house

 

[ilovemk76]

Really my company you can take out a loan for any reason what soever. A withdrawal has a lot of restrictions but loans are doable for any reason.

We have taken out 401K loans twice. Once I home had fire damaged so we took out the loan for remodeling. Our interest at teh time was 4% lower than any bank or credit union. The interest was paid back into my account.
The big downside was that, that chunk of change is no longer growing for you

my job was/is as stable as a job can get so it was a good decision for me.

I would use it again if it made sense for me.

Bold - One of the reasons we have not done this. There is also the lose of a job repayment.

We never have taken a 401K loan and would only as a last resort.

 

[crisi]

Yes, but what you did was a huge exception to the rule. Most people who are taking out 401K loans are doing so because of financial distress, not using it as a convenient bridge loan.

Again, two-thirds of that 30% taking those loans.....default on the loan, so that speaks for itself I think.

But to say it is ALWAYS bad is wrong. Never say never. All is seldom actually all.

There are times that taking out a 401k loan makes good sense. And it isn't always a "last resort" thing either. I do agree that the majority of 401k loans are bad moves.

 

[MrsPete]

But aren't you paying the credit card and personal loans back with after tax dollars too? Using the reasoning from a PP, if paying back the 401K with after tax dollars constitutes a "hit" of 30%, wouldn't paying a loan with a 7% interest rate with after tax dollars incur a 37% hit??? And with a loan or credit card, the interest you are paying is to somebody else, at least borrowing from your 401K means you are paying it back to yourself.

Yes, but after you pay off the credit card /personal loan, no one taxes you on the money a SECOND time -- that's exactly what happens when you repay a 401K loan.

Yes, you are paying interest back to yourself, BUT you're losing the interest that would've been paid to you had the money been invested. And, no, the loss of years of compound interest IS NOT equalled out by the interest you're paying to yourself.

From a math standpoint, it just doesn't work in the consumer's favor. As I said earlier, you can google this question and see good write-ups from financial experts as to why this is a financial nightmare.