Question of the Day – 401(k) Loans

July 21, 2008

Here’s today’s question(s) of the day:

Do you think it is too easy for people to borrow from their 401(k) plans? Have you ever borrowed from your 401(k)?

My wife and I have borrowed against her 401(k) when we bought our house in 1999. This was back in the day when her 401(k) was our only source of meaningful savings. Although it worked out well for us, I can’t say that I would recommend it for everyone.

What about you?

13 responses to Question of the Day – 401(k) Loans

  1. Um, horrible idea unless you’re trying to avoid bankruptcy or foreclosure. With the tax and the penalty involved, you’re effective interest rate is around 40%. REALLY BAD IDEA!

  2. I think it is easy to borrow from your 401K, but for many, that needs to be the case. Although I have never borrowed against mine, it’s nice to know that it is there in case I experience a true emergency. I would not recommend that people borrow just to borrow.

  3. If you’re thinking of borrowing from your 401(k) because you’ve maxed out your credit cards and home equity line of credit – DON’T DO IT. Instead, you should learn how to live within your means.

    However, if a 401(k) loan is necessitated by a medical emergency, or as JLP mentioned, a downpayment of a home – carefully consider the risks and your ability to repay.

    We’re getting a lot more requests for debit access to 401(k) at my firm, which is obviously a horrible idea.

  4. I think it’s a horrible idea to take money from your pension fund in most cases.

    I live in Europe. Here, the government prohibits people from removing money from their pension accounts, except to take a down payment out for purchasing a home.

    The only other exception is for self-employed people, who are allowed to take out some to start a business- dangerous in my opinion. (on the other hand, they are also allowed a larger maximum contribution to IRA-like funds)

    I think the assumption is that the government will end up responsible for you in your old age if you spend your pension to live now.

    If someone is out of work and has run out of unemployment benefits, then the government is also not allowed to make people spend down all their pension savings before allowing social help (welfare). They do have to spend down most of their other savings.

    I think this is a pretty reasonable system.

  5. I took a 401k loan about 5 years ago (I’m 30 now). At this point in my life, I would not do it again; however, it is hard for me to think that taking the loan at that time was a bad thing. It gave my wife and I the jumpstart we needed to pay down oppressive debt.

    Another thing we did was cancel a bunch of credit card accounts (once they were paid off from the loan). Generally, that’s something else I wouldn’t recommend now, because longer account histories help your credit score. But we knew having the card accounts open would be a temptation.

    The combination of forced payments taken right from my paycheck to pay the 401k loan, as well as the lower overall credit limit available to us, forced us to make some much-needed decisions about what we could and could not afford. To me, getting to that point was worth what I might not earn in the long run.

    Yes, the loss of some tax benefits sucks (dividends and capital gains on portions that I shift around during rebalancing still benefit from being tax free), but I did not pay any penalties on the loan. I guess what penalty you might have to pay depends on your company’s 401k plan.

  6. I haven’t made any loans against my 401K but I do think it is too easy- the 401K isn’t supposed to be an ATM! Unless it is a dire emergency that money should stay invested. If it is raided now what will happen in 20 or 30 years?

    -Rick

  7. In Canada we have RRSP’s (around what a 401K is), and there is a program called the Home Buyer Plan which allows you to borrow up to 20000 from your RRSP tax free and make even payments back to the RRSP over the next 15 years (1333.33 a year max).

    In my situation it made massive amounts of sense, since my work matched 6% of our salary to an RRSP and then I get the tax refund on the 6% that i put going in, then borrow the money from myself to buy a house.

    Now my regular matched contributions won’t generate as much of a refund over the next 15 years, but I have a house instead of an apartment; the HBP works for me.

  8. More people dip into their 401k’s then they would like to let on…

    Honestly…I don’t even think buying a home warrants tinkering with the 401k…

    401k, IRA, 403b shouldn’t be touched, unless a MAJOR illness or issue arise, until you reach 59.5…

    End of story…

  9. Yes, of course. As others have mentioned unless it is a dire emergency, I think the money should not be retrievable. That might limit you if you decide to completely change life directions (sell everything, move to Indonesia, etc.), and it might encourage folks NOT to participate… but I think the credit/debit cards linked to your 401k is just ridiculous.

  10. Borrowing for a 401k is a bad idea for several reasons. Reason 1, when your borrow you pay back with after tax dollars and when you retire you pay tax on the money again (not a good deal). Reason 2, you are robbing from your retirement, you will never get the gains from your 401k for the time the money was not in your account.

  11. I borrow from my 401K. I only borrow $1000 at a time and pay it back in less then one year

  12. I’ve borrowed from my 401(k), to pay off my auto loan, I would rather pay myself interest than the credit union.
    There are some key points though: 1) you need to continue contributing to your 401(k) in addition to the loan repayment. 2) have a safe job, to protect yourself from getting ‘downsized’ i.e. something in the healthcare profession and 3) you really only get double taxed on the interest you are paying back, not the principal of the loan. If I were to borrow $50k from my 401(k) today and pay it back in full next month with $50,060.00 only the $60 is after tax money b/c the $50k is the original amount I took out.

    The only downside would be job loss and if the investments I ‘had the money in’ would’ve earned a huge return that I missed out on.

  13. I’ll ditto what Traciatim said about the Canadian retirement account. I borrowed $20k from mine to buy my first house and it worked out great.

    Mike