Only the ignorant will take a loan out of their 401k. These people have been mislead into believing their 401k is a source of liquidity. This is total crap.
Yeah… Yeah… I know you can borrow against your 401(k) just like an Infinite Banking policy up to a point!
Your 401k plan will usually let you borrow as much as 50% of your vested account balance, up to $50,000. (Plans aren’t required to let you borrow, and may impose various restrictions, so check with your plan administrator.) You pay the loan back, with interest, from your paycheck. Most plan loans carry a favorable interest rate, usually prime plus one or two percentage points. Generally, you have up to five years to repay your loan, or longer if you use the loan to purchase your principal residence.
The opportunity cost
When you take a loan from your 401(k) plan, the funds you borrow are removed from your plan account until you repay the loan. While removed from your account, the money isn’t continuing to grow tax deferred within the plan. So the economics of a plan loan depend in part on how much those borrowed funds would have earned if they were still inside the plan, compared to the amount of interest you’re paying yourself. This is known as the opportunity cost of a plan loan, because you may miss out on the opportunity for more tax-deferred investment earnings.
Think about it this way… You have $100,000 in your 401k in 2012. You take out a loan for $50,000 and you pay it back in five years. During that five year period you would have missed out on almost 10% annual investment growth (compounded growth) during that time when the stock market was around 12,000 points at the beginning of 2012 and is now around 18,000 points!!!
In hindsight, that would be the dumbest thing to do. There is always another way to get the money you NEED… That’s NEED not want for something stupid!
Can you continue to contribute to the plan?
If you take a loan, will you be able to afford to pay it back and continue to contribute to the plan at the same time? If not, borrowing may be a very bad idea in the long run, especially if you’ll wind up losing any employer matching contributions.
What if your employment terminates?
Well then… you are screwed. If you terminate employment, your plan will typically provide that your loan is immediately payable. If you can’t repay the loan, the outstanding balance will be treated as a taxable distribution to you (reduced by any after-tax contributions you’ve made).
And if you’re not yet 59½, a 10% early distribution penalty may also apply to the taxable portion of your distribution.
However, if you borrow from a Roth 401(k) account and you don’t repay the loan, there will be no income tax consequences if your distribution is “qualified” (that is, your account satisfies a five-year holding period requirement, and you’re either 59½ or disabled). Even if your distribution isn’t qualified, only the earnings you’ve borrowed from your account, not your own contributions, will be subject to tax and potential penalty.
When should you consider a loan… NEVER!!!
It doesn’t make sense to take out a loan from your 401k ever. The math doesn’t add up in your favor. There is never enough investment gains through the plan since most 401k plans are highly diversified.. even they tell you it’s an aggressive growth plan. The rules of the plan are always rigged against you because it’s not your money until the company tells you it’s your money.
Plan loans never make sense. Some of my fired clients have taken loans to pay off high-interest credit card debt, or to purchase a home. These people didn’t have the guts to stick it out, reduce their current lifestyle and make the necessary sacrifices to pay back the credit cards or simply stop contributing to their 401k to save up for a home!
There are so many other options and sometimes it means asking for help instead of setting yourself up for financial failure. Ask your parents, friends, sell all your crap!
Why Invest In A 401k?
From the information above and the rules governing such a socialist, government program are limiting and have no guarantees for future growth.
Some of us believe that an employer match is ‘free’ money. Not so. All the money in the pot, including any growth, is taxed at ordinary income tax rates at some point in the future. Do you know what interest rates will be when you retire?
Do you see how bad it’s going to get from all the entitlements we have to pay in social security and medicare?
Study this chart:
Here is a better question: what is wrong with investing in a 401k?
Because the 401k is designed for people to be poor in retirement. Most financial advisors say you will be in a lower tax bracket in retirement because you will be earning less in retirement. I don’t know about you but I don’t want to live like a poor person in order to pay less taxes.
There is a better way to get what you want… it involves your discipline and a dividend paying, tax deferred, guaranteed life insurance policy. If you want to know more watch this video.