401K: Help Stop The Bleeding By Stopping The Borrowing
Most people don't need a 401k retirement plan. Still, many folks are convinced that these things are not tax traps and that somehow everything will work out OK.
If you are still on the fence about this, or you still like your traditional plan, you might as well get the most out of it. And, one of the best things you can do with your 401K is to leave it alone. Don't ever take a loan against your 401K if you plan on keeping it. Either cash it out or keep it in there, all of it.
The reason for this is that if you cash out your 401K, you will pay taxes, and a penalty, and that won't be fun, but it's a one time hit. When you take a loan against your 401K, that's the penalty that keeps on giving. First, you give up the earning potential of the money inside the plan, because these "so called" loans are actually a withdrawal of funds out of the plan (on a tax-free basis).
Most fixed-type investments are debt instruments. They are loans. Examples of this would be T-bills and bonds. In reality, you are lending either the Government or a corporation money in exchange for interest plus your principal after the term of the loan.
When you loan yourself money in a 401(k) though, you are simply replacing the interest you would already be receiving with interest payments from yourself. Remember, you have taken out money from your 401(k), and since it is not in your account while it's on loan, you are not earning interest in the stock, bond, or money market. You've simply substituted one borrower for another or changed the source of interest.
In addition, the interest payments you make back to your 401(k) are with after-tax dollars; and consequently, when you make a final distribution on that money, you will pay tax again on the money you paid back as interest.
Every time you take a loan from your 401k plan, you repeat the process of building up funds that will be taxed twice. This is incredibly unfortunate and necessary. The gimmick of the plan (the tax savings) can then become nullified through even moderate borrowing throughout your lifetime. This is on top of the regularly required taxes on distribution.
If you are still on the fence about this, or you still like your traditional plan, you might as well get the most out of it. And, one of the best things you can do with your 401K is to leave it alone. Don't ever take a loan against your 401K if you plan on keeping it. Either cash it out or keep it in there, all of it.
The reason for this is that if you cash out your 401K, you will pay taxes, and a penalty, and that won't be fun, but it's a one time hit. When you take a loan against your 401K, that's the penalty that keeps on giving. First, you give up the earning potential of the money inside the plan, because these "so called" loans are actually a withdrawal of funds out of the plan (on a tax-free basis).
Most fixed-type investments are debt instruments. They are loans. Examples of this would be T-bills and bonds. In reality, you are lending either the Government or a corporation money in exchange for interest plus your principal after the term of the loan.
When you loan yourself money in a 401(k) though, you are simply replacing the interest you would already be receiving with interest payments from yourself. Remember, you have taken out money from your 401(k), and since it is not in your account while it's on loan, you are not earning interest in the stock, bond, or money market. You've simply substituted one borrower for another or changed the source of interest.
In addition, the interest payments you make back to your 401(k) are with after-tax dollars; and consequently, when you make a final distribution on that money, you will pay tax again on the money you paid back as interest.
Every time you take a loan from your 401k plan, you repeat the process of building up funds that will be taxed twice. This is incredibly unfortunate and necessary. The gimmick of the plan (the tax savings) can then become nullified through even moderate borrowing throughout your lifetime. This is on top of the regularly required taxes on distribution.
About the Author:
Only so much information can be covered in one article. If you would like more detailed information about any aspect of personal financial planning, please visit David's website.
posted by Credit Counseling at
4:12 PM
0 Comments:
Post a Comment
Subscribe to Post Comments [Atom]
<< Home