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

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.

About the author  ⁄ Ted Jenkin @ Your Smart Money Moves

Ted Jenkin @ Your Smart Money Moves

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Ted Jenkin is a frequent guest columnist for the Wall Street Journal and Headline News Weekend Express. He is the co-CEO of oXYGen Financial. You can follow him on LinkedIn @ www.linkedin.com/in/theceoadvisor or on Twitter @tedjenkin.

Securities offered through Kestra Investment Services, LLC (Kestra IS), member FINRA/SIPC. Investment advisory services offered through Kestra Advisory Services, LLC (Kestra AS), an affiliate of Kestra IS. oXYGen Financial is not affiliated with Kestra IS or Kestra AS. Kestra IS and Kestra AS do not provide tax or legal advice.

The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor regarding your individual situation. 

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One Comment

  • September 2, 2018

    Excellent post! I helped manage a 401k plan as a member of the committee that ran it and one other bad feature of borrowing from our 401k plan was that if you took out a loan you were no longer able to contribute to the 401k until you paid the loan back in full. And since many of our employees would immediately get a second loan as soon as the first one was paid they essentially were prevented for years from participating in the plan. It just killed their retirements in my opinion.

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