401K Retirement Ruined By Loans
Almost nobody needs a 401k retirement plan. Even so, some people are convinced that these things are not tax traps and that somehow everything will work out OK.
If you just can't bring yourself to ditch your 401k, that's OK. You can get something out of it by just leaving it alone. Don't go borrowing money from it. Even if you qualify for the so-called "hardship" provisions, leave it be.
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).
Bonds represent a fixed investment. The amount of the return is known in advance. You are lending either a corporation or the U.S. Government money in return for interest plus the return of your principal.
Loaning money to yourself is basically replacing the interest you get from one source with another. That's unfortunate in some respects because the money is not in your account. While this may be good during a market downturn, it essentially represents a higher savings rate with 0% return from investments.
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.
You do this every time you take a loan. So, rather than getting beaten up once, you get beat up twice. Who would knowingly do that? Now that you know, don't do it.
If you just can't bring yourself to ditch your 401k, that's OK. You can get something out of it by just leaving it alone. Don't go borrowing money from it. Even if you qualify for the so-called "hardship" provisions, leave it be.
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).
Bonds represent a fixed investment. The amount of the return is known in advance. You are lending either a corporation or the U.S. Government money in return for interest plus the return of your principal.
Loaning money to yourself is basically replacing the interest you get from one source with another. That's unfortunate in some respects because the money is not in your account. While this may be good during a market downturn, it essentially represents a higher savings rate with 0% return from investments.
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.
You do this every time you take a loan. So, rather than getting beaten up once, you get beat up twice. Who would knowingly do that? Now that you know, don't do it.
About the Author:
About the author:David Lewis, RFA is a professional financial adviser. If you would like more detailed information about any aspect of personal finance, please visit David's website.
posted by Credit Counseling at
4:33 AM
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