Have you ever needed a large amount of money and dipped into your 401k to get it? Maybe you wanted to put a down payment on a house, had an emergency, or some other reason you needed the money.
If you did dip into your 401k, was it really worth it?
Taking Money From Your 401k Has Consequences
When you withdraw funds from your 401k account to take care of a present need, it can be very detrimental to your future. Even if you take the money out with the best intentions, it can still have far reaching consequences that can hurt your finances for the rest of your life.
There Are 2 Ways to Get Money From Your 401k
There are two ways you can access money from your 401k account before retirement, and each of them have their own unique consequences:
- 401k Withdrawal- Withdrawing money out of any retirement account, including a 401k, means you’ll take a large financial hit. You are required to pay your usual tax rate on the withdrawal, and you’ll also have to pay a 10% penalty on top of that. The result is that you immediately end up losing as much as 35-50% of the your withdrawal in taxes and penalties. You can get a more detailed explanation here.
- 401k Loan- When you take out a loan from your 401k account, it has to be paid back with interest, just like any loan. The good news is that you don’t have to pay taxes or a penalties on the loan, but that doesn’t mean that a 401k loan is problem free.
The Drawbacks of a 401k Loan
Taking a loan from your 401k can have huge consequences for your future. Here are 3 reasons why:
- You’ll Probably Do It Multiple Times- When you take a loan from your 401k, you tend to do it again. It has a tendency to become a habit, which can cost you tens to hundreds of thousands of dollars in growth over the years.
- You’ll Contribute Less- While you’re paying off a 401k loan, you probably won’t be making any contributions to your 401k. This also hurts the long term growth of your account and ends up costing you a ton of money over the long haul.
- Your Return On Investment Is Not As Good- Even though you pay back the loan with interest, you’re likely going to get a better return in a traditional investment such as a mutual fund. More importantly, with a traditional investment, someone else is paying the interest, and it’s not coming out of your own pocket. This is another way you can lose tens to hundreds of thousands of dollars of investment growth during your lifetime.
Don’t Borrow From Your Future
When it comes down to it, withdrawing or borrowing money from your 401k account can be have a very negative impact on your present, as well as your future financial security. I’ve always taught that borrowing money from any source always makes you poorer.
But when you withdraw or borrow money from your 401k or other retirement account, it’s a double whammy of lost investment growth that I just don’t think is worth it in the long run.
My Recommendation
If you feel like you absolutely must borrow money, don’t make the mistake of dipping into your 401k to do it. Even better, educate yourself about your situation and understand that if you really want to, you never have to borrow money again.
You just have to learn to think and act differently by putting together a solid plan for getting out of debt and do what it takes to make that happen.
When you learn to get complete control over your money instead of letting your money control you, then you start being a winner financially. Here’s how you can get started.
Your future will be glad you did!
Question: Have you ever taken money out of your 401k to take care of an immediate need? Leave a comment and tell me about it.
Resources:
Why You’re in Debt and What You Can Do About It
I have never and will never take a loan out of my retirement. Never, never, NEVER. And while I abhor government interference if almost everything, I would advocate a regulation making it impossible to do so. You can’t take a loan out of Social Security, why should you be able to with a 401K or any other form of retirement savings?
You sound like a smart woman to me! I totally agree.
It must be a “Kathy thing”, because I agree with what Kathy wrote. Never, ever, ever will I borrow from what is allocated for my future retirement. ONCE I borrowed against stock, with almost disastrous results. It was for a down payment on a house and I was waiting for my late husband’s estate to be finalized. Not wanting to lose out on the good deal for the house, I borrowed against my stock. Then I got all over the lawyer’s case, insisting he give me the money NOW. It had been 3+ years, and I was losing patience. Well, lucky for me I got the check from the lawyer the day before I was informed my loan was being called. When was this? October 1987 — the U.S. stock market took a nose dive, with my loan being more than the stock was worth.
Wow, you almost had a major problem on your hands. Glad it all worked out. Obviously you know better now that that’s a bad idea.
Thanks Kathy!
I agree, It’s best not to get into the habit of drawing on your retirement accounts.
I did take money for a retirement account that I had rolled over a years ago when I left an old job. There was $3,000 in the account. I took it out to replace my Mac that I need for blogging. Wellllllll…… Not only the 10% penalty, but I ended up having to pay about 40% of that in taxes, which screwed me for taxes this year. Lesson learned: never again! I would have been better charging it with a 0% introductory rate credit card.
Serena @ Thrift Diving
Ouch!!! I don’t ever recommend credit cards, but you definitely would have gotten out better that way instead of using retirement funds. Sometimes we have to learn the hard way, huh?
I’ve never made that particular mistake, but I’ve done plenty of dumb stuff with money too. Been there, done that, learned my lesson!
Yes, you should prevent having debt. Some debts usually gets higher. Once tasted always wanted. So for now, start saving your money. Save today, Save tomorrow, Save for the future!
Indeed. It is a mistake in getting into the habit of drawing on retirement accounts. Great decision!
You’re missing the biggest reason — the exemption on 401ks/IRAs in bankruptcy.
If the worst happens to you financially (you lose your job, etc.), NEVER touch your 401k. Why?
If you end up having to declare bankruptcy, a 401k/IRA CANNOT be touched by your creditors.
So would you rather withdraw money from your 401k/IRA to meet an emergency, have it taxed/penalized at high rates, and THEN maybe declare bankruptcy and end up with nothing in your retirement account? Or would you rather DECLARE bankruptcy, and come out of it without debt but WITH your full 401k/IRA?
Great point. Don’t sacrifice your future because you have trouble now. That would probably one of the most inefficient uses of money I can thing of.
Thanks Chaddog!