Borrowing from your 401k Plan – Is it always the wrong thing to do?
When times are tight, sometimes we need to dip into our savings to make ends meet. If the money you are bringing in from your paycheck is not enough to pay your bills or the interest you pay on credit cards or other debts gets too high you will have to get the money from somewhere. Or even personal reasons such as health and family issues.
Over the last few years, many people have used all of the equity in their homes by taking out home equity loans and now because of falling home prices they often owe more than their homes are worth. This has led consumers to look for other sources of cash to pay their growing debt and one of these sources is borrowing from their 401(k) plan.
I remember about 9 years ago when I had to borrow money from my 401K plan and use that money for down payment of a home. The original term of the loan was 15 years though I was able to repay that loan in a little less than 5 years time. It really was not a bad decision after all as my home have already doubled in value since. It was a decision that I had to make at that time for family reason.
More information on 401K plan and why you do not have to do what I’ve done…………..
A 401(k) plan, as you may know, is a retirement account. It is tied to your place of work and a portion of what you make each pay period is often deducted and put directly into these accounts. Borrowing from these accounts is pretty easy because after all, the money is yours. It can seem like a good solution to your short-term problems but in reality, borrowing from your 401(k) may do you more harm than good.
First of all, because as of the writing of this post, most accounts have lost a considerable amount of value because when you take out a significant amount of money you are actually cashing in a significant amount of shares. In an investment account, the only thing that really matters is the accumulation of shares. For instance, if you own 1000 shares in your 401(k) and each share is worth $50, your 401(k) is worth $50,000. If you need to borrow $10,000 from the account you only have to cash in 200 shares. If, on the other hand your account value is suffering such as in the current economy and each share is only worth $25, you would have to cash in 400 shares in order to get that same $10,000. When stock prices go back up, you will miss out on the gains of a whopping 400 shares because you decided to cash in when the account value was low.
The other huge downside to borrowing from your 401(k) is simply that you drastically reduce the effectiveness for which it was created. When you take large sums of money out of your 401(k) it can take a long time to put it back to thus putting a severe damper on how your 401(k) will be valued at the time of your retirement. If you are in a financial crunch, use borrowing from your 401(k) is the absolute last resort but instead look for other means to help you through the downtime.
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Tags: 401k, 401k plan, IRA, Retirement Planning, thrift savings plan
This entry was posted on Tuesday, April 7, 2009 at 7:27 am and is filed under 401k, IRA, Retirement Planning. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
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