Borrowing from 401k – It’s a Retirement Account, Not a Cash Money
It’s not just choosing the right retirement investment that helps 401k grow faster. It’s keeping your hands off them too. Most plans permit you borrowing from 401k against the account balance for compelling reasons. Those all-too-compelling reasons may reduce the amount you’ll be able to draw someday from your 401k.
If retirement, early or otherwise, is your dream, you can’t view your 401k as a source of ready cash. Many 401k plans let you borrow from your assets. Recent statistics indicate that roughly one-third of the participants have loans outstanding. You’re charged interest on the loan, but you’re paying back the interest to yourself.
Some financial experts encourage borrowing from 401ks. They’re convinced that 401ks are the perfect source of funds to pay for major expenditures that crop up over your lifetime. For example, many people borrow from their 401k to pay for a child’s education. Money in a 401k account is not included in the figures that financial aid officers use to determine an aid package for a student.
Despite the advantages of borrowing 401k money, it can risks your retirement planning. If you are leaving your job, you’re obligated to repay any loans against your retirement account. Many plans require repayment of the loan within 30 days. Failing to pay back a loan might be viewed as a distribution from the account and subject to a 10 percent penalty.
When people borrow from a 401k account, they may stop making contributions. In fact, your employer’s plan may not permit you to make employee contributions while a loan is outstanding. To borrow from your employer’s plan, you’ll need to pay back the money with interest and stick to the payment schedule. Some people may not be able to adhere to that schedule and still contribute to their 401k. If you can’t, you’ll lose a lot of money over the years in your 401k. Furthermore, even though you’re paying interest on the loan to yourself, the rate of return may be far less than what you would make in the stock market.
Sometimes, your 401k will suffer from a marital dispute. A friend who dreamed of early retirement went through a painful divorce while in his early fifties. He lost half his 401k in the divorce.
Changing jobs is another problem that can affect the amount you’ll wind up with in your 401k. According to U.S. Bureau of Labor statistics, working women who are over 25 change jobs every 4.8 years. These job changes inhibit the growth of retirement plans.
You may not be eligible to participate right away at your new place of employment. At many firms, you’re not able to participate in the 401k plan for at least a year. Losing that opportunity will hurt your retirement savings enormously, especially if you change jobs frequently during your career. On a positive note, more companies have reduced or eliminated the waiting period to enroll in the firm’s 401k plan. In its ads to attract employees, one national mortgage lender promised 401k eligibility after only 30 days.
Though you are always vested for the funds you’ve invested in the plan, you may not be for your employer’s contributions. You might have to wait five years until there’s full vesting of your employer’s contributions to the plan. Before taking a different job, you should be considering how much you’ll lose in your 401k. One young actuary worked for an insurance company that offered a generous match of her contribution. The woman was shocked at how much money was forfeited from her account when she left before her vesting date.
Employers don’t always interpret the plan rules correctly. At a company my wife worked for, the employer withdrew its contribution after she left the company. It refused to respond to her request for information as to why the money was withdrawn from her account with Fidelity Investments. Fidelity washed its hands of the matter and said it was the employer’s decision to make. Fortunately, after the Department of Labor intervened, the employer remembered that my wife should be credited for service with the parent company and the money was returned to her account.