Five Reasons You Never Want To Borrow On Your 401(k)

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Five Reasons You Never Want To Borrow On Your 401(k)

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Five Important Money Questions To Ask Your Parents

September 02, 2018

Many millennials are stretching financially to buy homes, and the numbers are getting scary. People in the younger generation are modeling behavior that is far riskier and more dangerous than they even realize for their future. According to a new survey by the Bank of the West, approximately 1 in 3 millennials say they raided either their 401(k) or even worse liquidated part of their IRA to put a down payment on a home. Even more millennials are tapping these retirement accounts to pay down their growing student and personal debt. There is a reason these are called "retirement accounts", and specifically there are five enormous reasons you never want to borrow on your 401(k).

  • The Magic Of Compounding - In a recent story I did on CNN Headline News, I discussed the power of compounding. A 25-year-old who puts away $300 a month and hypothetically earns 8%, will have roughly 1 million dollars at the age of 65. A 35-year-old who puts away $300 a month and hypothetically earns 8%, will have roughly $400,000 at the age of 65. A 45-year-old who puts away $300 a month and hypothetically earns 8%, will have roughly $200,000 at the age of 65.

If you have $100,000 in your 401(k) and borrow $50,000, there will be a period of up to five years where the majority of that $50,000 isn't in the magic box compounding for your retirement. This potential lack of growth could be the difference between becoming a millionaire and having to wait several more years to retire.

  • You Are Being Double Taxed - When you borrow from your 401(k), not only are you paying interest on your payback, but even worse you are using after-tax dollars to pay back your loan. This means you put the original dollars away pre-tax (assuming you didn't do the Roth 401(k)), and then you are using after-tax dollars to pay back your loan only for it to be taxed again when you take the money out down the road.
  • You Sell Low And Buy High - When it comes to investing, the basic principle is to buy low and sell high. However, when you sell your shares in your 401(k) plan and buy back the shares 3 or 4 or 5 years down the road, the likelihood is that you will buy the same exact shares back at a higher price. So, essentially you are undermining the basic concept of buying low and selling high and instead you are selling at a price today which you will likely buy back higher down the road.
  • You Have Risk If You Get Fired - If you decide to leave your employer or your employer decides to leave you, most plans will give you 90 days to pay back the loan in the 401(k) plan. If you have chosen the pre-tax savings plan in the 401(k), that loan if not paid back will end up being treated as taxable income. Not only does this mean it gets added to your taxable income for that particular tax year, but also can put you in jeopardy to pay a 10% IRS penalty if you are under the age of 59 ½. This means you could pay 30% to 50% tax depending on your family tax bracket.
  • It Sets Up A Bad Foundation For Your Financial Plan - Once you begin using your 401(k) as a savings account, it begins to destroy the integrity of your financial plan. You may no longer think you need a cash reserve because you will use your 401(k) as your cash reserve. However, you can generally only take one loan out at one time and this strategy can be very detrimental to your overall financial plan.

If you want to set up a time to discuss how to consolidate your 401(k) plans, please go to oXYGen Financial to set up an appointment.


If you would like to receive more information on making smart money moves for your future, be sure to contact us today!

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