Problem #3 – Loans
“Brother, Can You Spare A Dime?” (Bing Crosby 1932)
There has been a popular myth lately that it is OK to borrow against your 401(k) plan. The most common thing I hear from those I talk with is “I’m paying myself interest!”
If you believe that, I’ve got some GM stock for you that you should buy!
All kidding aside, this could be the worst idea ever with regards to retirement savings plans. Dave Ramsey, nationally syndicated financial expert, has some thoughts on this as well.
“Never, ever borrow on your retirement.” Dave says in response to this question. http://www.daveramsey.com/etc/askdave/index.cfm?event=dspAskDave&intContentItemId=7802
Yet, almost 1 in 5 401(k) plans (18%) have a loan against it. This is according to Transamaerica for Retirement Studies in their annual survey. www.transamerica.org
Reality is NOT “paying yourself interest”, but rather paying credit card interest to borrow your own money. OUCH!
What are the Tax Consequences on a 401(k) Loan?
When you borrow, you have 2 options –
1. Pay it back.
2. Don’t pay it back.
Of these, the best of course is to pay it back. However, did you know that when you do, you face DOUBLE TAXATION? You are paying interest with after-tax dollars that will be taxed AGAIN at withdrawal.
What about not paying it back? Well, obviously your investment takes a hit & you could be taxed up to 35%, and face the early withdrawal penalty of 10% if you are younger than 59 1/2. If you leave the company, the loan is automatically listed as a withdrawal, so it is “repaid”.
Again, you are paying interest, not to yourself, but to a lender on your own money.
What does this mean to your investment? It lowers the balance, certainly. How much depends on how many times the loan is taken, what amount, investments, payback and several other factors.
Please don’t “Spare a Dime” from your 401(k). You will need this money later!!
For more information, please contact me, Dean Voelker, at www.helpmy401k.us