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Should You Borrow Early From Your 401(k) Plan?

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Tough economic times have caused many to tap into any financial resource they have.  Burdened with debt, job loss, supporting kids through school along with other financial pressure make more difficult to get by each month.  For many, an employer-sponsored 401(k) retirement plan has been a source of forced-savings and therefore, tempting to touch.  But should you?  Is it a good idea?

Also, have you thought about cashing out completely, your 401(k) plan?  Have your heard that fellow co-workers, family and friends have done the same thing?

Here’s how we addressed this question with Tera Williams, reporter and journalist,  from FOX Chicago:

Here are some additional thoughts:

401(k) plan is for retirement planning, not emergency savings – I recommend that we should always have at least three buckets of money established in our budgets.  These buckets are LONG-TERM, MID-TERM and SHORT-TERM planning.  For example, a short-term bucket would be an emergency savings account where the money is easily accessible.  A mid-term bucket bucket would be where you would save for a new car, computer, home remodeling, etc.  This is where you save up for bigger purchases.  A long-term bucket is earmarked specifically for either college savings for your child or retirement planning.  Unfortunately, many people have put all their savings in one account, or bucket, and use the cash here for multiple financial goals and decisions.

What makes it difficult is that the financial institution where you have your employer-sponsored 401(k) plan, by law, sends you statements via the mail so you can be informed.  Worse yet, they give you internet access so you can see in real-time the balance of your 401(k) plan.  For common people, this is just WAAAAAY too much temptation.  It is the biggest pot of money they have ever accumulated on a month-to-month basis.  It takes a bit of will-power to not have an emotional desire to touch it.  Tell me, did you find yourself end up with “sticky” fingers?  It’s okay…it’s normal…please share!

Choose the proper financial vehicle for the proper time frame – In Chicago, there are two major airports.  O’Hare is located on the Northwest side of downtown Chicago, whereas Midway is located on the Southwest side. If I needed to get from O’Hare to Midway, would I spend $250 for an airplane ticket to travel 20 miles (assuming that you could actually buy a plane ticket for this)?  Or would I take public transportation, hop in a cab, or simply drive there in my car? Either option would cost less than $50 and keeps me away from the headaches of traveling through an airport. More importantly, I would get there FASTER!

Here’s my point.  I find that many people end up saving for their long-term financial milestones (retirement planning) in short-term financial vehicles (checking, CDs, money-market and coffee cans<—LOL!)  and save for short-term financial milestones (emergency savings) in long-term financial vehicles (401k, IRA, Deferred Compensation, 403(b), Thrift Savings Plan, etc)

For example, taking money out of your 401(k) not only stunts the growth of your future savings and overall retirement plan, you end up paying unnecessary costs, fees and interest rate in favor of the financial institution.  I find that when people “borrow” money from their 401(k), many people do not end up paying it back.  If it is not paid back, the amount you borrowed and have not paid back is considered an early distribution and subject to federal income tax, state income tax AND if you are under 59 1/2 years old, a 10% premature withdrawal penalty.  Yes, this could easily totals to 30+%, literally over a third of your own hard-earned savings and employer contributions, taken away from you.  Plus, this is assuming that you stay in the same income tax bracket, based on the amount that you may have borrowed from your 401(k)!

401(k) employer retirement plan savings is NOT a financial plan – When taking a look at your overall financial picture, your 401(k) plan is strictly a component.  It is a piece to the puzzle.  It is NOT your financial or one-and-done retirement plan!  Let me give you an example, that I relate to…and hopefully you can follow allow. Indulge me!

It’s a military metaphor, so…AAAAATEEEENNN-HUH! (That means lock your body at the position of attention and give me your eyes and ears, in military language!)

In the Marine Corps, a basic 4-man fire team would consist of members who have different responsibilities and equipped with different weapons.  You would have your team leader, who carries an M-16 rifle w/M-203 grenade launcher affixed.  Then you would have your point-man or scout, whose job was to navigate, lead the way, who had a keen sense of observation while carrying an M-16 rifle.  Then you would have your automatic rifleman, or machine gunner, who carried a  fully-automatic M-249 SAW.  Beside him would be the assistant automatic rifleman, who carried a tripod, additional ammunition and armed also with an M-16 rifle.

In other words, each man had a different role and function within a small 4-man team.  If everyone carried the sexy, fully-automatic M-249 SAW machine gun, it would limit this team’s speed to maneuver and overcome certain obstacles.  It would be more difficult to “shock and awe” the opposition, through fire and maneuver.  Only together, do they make up a team and able to perform at a high level.

Your personal finances and overall financial plan operates in a similar way.  You need different financial vehicles that can get you to financial milestones in your journey through life, that enables you to have less headaches, worry and fear.  The challenges of life are bad enough not to be compounded with being financially unprepared.

Having a 401(k) plan as part of your overall financial plan, should be accompanied by an emergency fund, a life insurance package and a tax-free retirement vehicle.  Do you have these areas addressed and accounted for?  It’s a great start!

As a financial strategist, I am always thinking, “What if?”  By disposition and personal experience, I plan for the worst but expect the best.

The Bottom Line about Your 401(k) Employer-Sponsored Retirement Plan

Thinking that a 401(k), pension, or Social Security contribution (FICA) established through your employer will take your through your golden years is not only short-sighted, but reckless.  Think about it.  When you were finally eligible to enroll in your company’s 401(k) plan, did they take the time to review the other aspects, scenarios and dynamics of your total personal financial situation?

Don’t get caught up looking at your accumulated 401(k), IRA, 403(b), Deferred Compensation Plan cash balance with too much admiration.  The cash that is there…heads up.  It’s not all yours.  WHY?  Once you start pulling money out in retirement, after the age of at least 59 1/2 yrs old, you will most likely find ourselves in a higher federal income tax bracket than we are in today…you’ll have to give up a chunk of each cash withdrawal(s) every year, in income taxes.  As others have said, “Uncle Sam has a permanent lien on your 401(k) savings!”

Here’s my personal opinion…(which should not be misunderstood as giving you investment advice).  The 401(k) enrollment adviser is like a vendor to a 7-11 convenient store.  Nice people as they can help you stock the shelves with chips and soda.  However, they may not necessarily help you run a successful store and business.

Get it?

Lastly, try not to fool yourself by borrowing early from your 401(k) plan.  If you find yourself lacking financial discipline, chances are, you will not pay it back and have to eat the taxes and penalties  Just don’t go there.

What About You

Do you have a scenario where you borrowed or cashed out your 401(k) plan and only received a small portion of it when you got the check in the mail?  Or did you borrow from your 401(k), thought you were going to pay it back and ended up paying lots of taxes on it when you received a 1099 from the investment or financial institution?

In a future post, I will share how you can safely take money from your 401(k) plan…while still working at your job!

In the meantime, please share a quick story about tapping into a 401(k) plan and what you wished you would have known before doing so, in the comments section below!

Would you like to have a brief, 30-minute financial review with a Money Smart Coach?  Do you have questions about your personal financial situation that the 401(k) enrollment advisor may not have covered with you?

Give us a call at 708.686.2000 x8, leave a message and we will call you back to arrange a brief discussion.  Or, you can email us: [email protected]

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