5 Reasons NOT to Tap Into Your 401(k)

Written August 24th, 2010 by
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3 comments

Suzanne LucasTimes are tough. People are over-extended. Sometimes desperation can lead us to consider our 401(k) as a savings account that could save the day. Our 401(k) should be the LAST option for cash. Here are five reasons reinforcing why this is a really bad idea, straight from CBS MoneyWatch’s “Evil HR Lady”, Suzanne Lucas:

  1. 401k loans are called when you leave your job. It doesn’t matter if you are fired, laid off, get sick and have to leave, have a baby and want to stay home with it, found a new dream job, or you want to join the Peace Corp.  When you are no longer employed by that company, your 401k loan is due shortly thereafter.  If you can’t pay up, you have to pay taxes and penalties on the loan amount.  And if you can pay up, what are you doing taking the loan in the first place?
  2. Your job is not secure. Yes, I know you think that your job is secure.  I’ve laid off thousands of people who once thought their jobs were secure too.  Your company could hit a rough patch, take a new direction, get bought out or just decide they don’t like you. Trust me on this one.  Your job is not secure.  And all the HR lady (even a nice one) can do is offer sympathy.  We can’t change the rules that make the 401k loan due upon termination.
  3. You can’t change jobs. With a 401k loan hanging over your head you are trapped in your current company.  If a headhunter calls up and your dream job appears, do you really want to be trapped by the $10,000 loan you took out?
  4. If you don’t have the money now, what makes you think you’ll have extra to repay the 401k later? Save up for what you want first, rather than making payments on what you’ve bought.  If you can’t save the money now, you won’t be able to make the payments either.  This will add stress to your life, and you don’t need this.
  5. It ruins your dollar cost averaging. Okay, that’s financial speak not normally uttered by HR people such as myself.  But, essentially, taking a little bit of money out now can cause big differences in the long run.  Joshua Kennon explains more aboutdollar cost averaging at About Investing for Beginners.

Read the Entire Article at CBS MoneyWatch

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This entry was posted on Tuesday, August 24th, 2010 at 2:02 pm and is filed under 401k help, investing, investment behavior, investment education, retirement. You can subscribe to any comments to this entry via RSS 2.0. You can leave a response, or trackback from your own site.

  • http://www.harvestcapitaladvisors.com Brian D Gawthrop, CFP, AIF, QPFC

    I agree that one shouldn’t take loans unless it is truly the only resource for an urgent need. However, I would like to point out that if you leave or if you are terminated most plans require the loan to be paid back within 30 or 60 days. Any outstanding balance that isn’t paid back within the time frame is considered in default and is treated like a premature distribution. In other words, your unpaid balance is treated as if it were taken as a distribution on the date of termination. Ordinary income taxes will be due on the outstanding balance (remember, you’ve never paid taxed on this $$) as well as a 10% penalty. This is a problem for most people who take loans because they don’t have extra $$ laying around… that is why they took the loan out in the first place. For anyone who has taken a withdrawal from a traditional IRA before they were 59.5 years old you will recognize the same taxes/penalties.

  • BenefitJack

    Simply, loans are not leakage unless not repaid. Sure, if you take a loan and you have no intentions of paying it back, or if you have no intentions of paying it back if your employment ends, it really wasn’t a loan but a withdrawal. Absolutely, positively agree with you that premature withdrawals ar esomething to avoid … unless you are facing a period of unemployment with minimal wages (where, the distribution may actually be more favorably taxes than it would if held until retirement).

    Simply, the focus should be not on denying people access to their savings when they need it. The focus should be on improving repayment provisions. We have done that at my company. Not only can you continue to make loan payments post-separation, you can also initiate a loan post-separation from service.

    And, unless you provide reasonable access to the assets, you will dampen participation. There are a ton of studies out there that show loans from qualified plans, done right, actually improve worker’s financial position.

    Dollar cost averaging is an interesting issue to raise, not sure what you mean since few plans suspend associate contributions and company match when a loan is outstanding, and both the worker’s contributions, company match, repayment of loan principal and loan interest all are probably subject to dollar cost averaging effects, favorable or otherwise.

  • http://www.harvestcapitaladvisors.com Brian Gawthrop

    I agree that one shouldn’t take loans unless it is truly the only resource for an urgent need. However, I would like to point out that if you leave or if you are terminated most plans require the loan to be paid back within 30 or 60 days. Any outstanding balance that isn’t paid back within the time frame is considered in default and is treated like a premature distribution. In other words, your unpaid balance is treated as if it were taken as a distribution on the date of termination. Ordinary income taxes will be due on the outstanding balance (remember, you’ve never paid taxed on this $$) as well as a 10% penalty. This is a problem for most people who take loans because they don’t have extra $$ laying around… that is why they took the loan out in the first place. For anyone who has taken a withdrawal from a traditional IRA before they were 59.5 years old you will recognize the same taxes/penalties

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