Financial Planning for Generation X & Y Women
 
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Expert Q&A Archive

02/02/2010
Should I borrow from my 401k account?
I'm thinking of borrowing from my sep/401k account in order to pay my bills. I thought of allotting for the taxes and investing same in an interest bearing account. I have a budget that I'd like to start but can't seem to start it due to the debt I already carry. What is your advice? Please help.
Kris Freeberg:
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You need more income. You're trying to fit ten pounds of you-know-what into a five pound bag. Use the budget to calculate how much income you need, then figure out a way to earn it. Any other approach just rearranges the deck chairs on the Titanic.
Jeff Kyle:
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Good question, but you may not like the answer! Another consideration is if you are not 59 and a half years old, you may also be subject to a 10% penalty on the money you cash out! That money has a specific intended purpose (retirement). I would recommend that you figure a different way of paying off your debt! You won't find an account that will pay you enough interest to offset for penalty and taxes! If you do, please tell me where so I can put my money into it as well! Best to you!
Gail V. Marquet:
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Don't borrow from your 401k; just stop contributing to it. If you borrow against it and then leave for any reason before it is paid off in its entirety, you must pay the full amount back in 60 days or be taxed on the unpaid amount at about 40%. Stop contributing to it and use that money to pay down your debt. Stop using and cancel all credit cards and operate from cash only. You'll be surprised at how much you don't spend when you're paying cash.
Heather Green:
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I rarely recommend borrowing against a retirement fund. Generally speaking, borrowing retirement funds is extremely expensive, and the spending pattern that caused the debt in the first place isn't addressed. If you can afford to put aside money in an interest bearing account, why not use power payments to pay down the debt more quickly, or sign up for a debt management program if the interest rates are too high? I think you could really benefit from speaking to a financial counselor to help review debt repayment options, and the pros and cons of each. You can look on the internet at www.nfcc.org to find a legitimate credit counseling agency in your area.
Delores Lenzy - Jones, CPA, CIA:
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You should never borrow from your 401K to pay your bills! This is for retirement. Consider a second income source like a home-based business or a second job. Also, consider reviewing your spending habits and cutting back to absolutely necessary expenses.
Frank Wells:
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Sounds like a bad idea unless you meet the hardship provisions of your plan and you are able to avoid paying taxes on the withdrawal. And a 10 % penalty for early withdrawal if you borrow the funds for over 62 days. Check the plan details before you decide.
Pablo M. Bianchi, CFP:
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I would not recommend taking the money out without a plan (budget). If you invade your retirement account you are utilizing your last line of defense. You should have a budget in place regardless of how much debt or profit you have, since a budget will act as a measuring tool to determine your inflows and outflows of cash (money coming in and money going out). Sometimes budgets don't look good, but that is the whole idea--to have one so that you can be accountable to the only person that matters in this situation, "yourself".
Gerri Detweiler:
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Please try to find another way to deal with your debt. Money in your retirement account is protected from creditors, so it's probably one of the safest assets you have. In addition, with a five-year repayment plan, you may find yourself with a new loan and the same cash flow problems you have right now. It will be all too tempting to start using your credit cards again. Finally, if you leave or lose your job you may have to pay back the loan immediately or pay taxes and a penalty.
Fara Goodwin:
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The U.S. Department of Labor, Employee Benefits Security Administration (EBSA), administers Title I of the Employee Retirement Income Security Act of 1974 (ERISA). ERISA governs certain provisions of private-sector, employer-based pension plans. Although we do not render investment advice, we generally dissuade individuals from cashing out retirement plans to pay off debt for the following reasons:

1. You lose - your money is gone and will never have the opportunity to be replaced. Yes, you may add to your 401(k) in the future, but the opportunity to recapture the funds you take [out] is irreplaceable.

2. You pay penalty taxes - you will automatically be taxed a 10% penalty fee for early withdrawal. At the end of the calendar year, you are taxed again, as the distribution becomes labeled as taxable income and that is yet another % that is deducted from the amount. All told - depending on your tax bracket--up to 50% of the amount could be lost to taxes. [Editor's Note. Mandatory income tax withholding of 20% applies to most taxable distributions paid directly to you in a lump-sum from employer retirement plans regardless of whether you plan to roll over the taxable amount within 60 days, according to the Internal Revenue Service's Tax Topic 12 (Lump-sum distributions).].

3. A 401(k) should not be treated as a savings account. It is a long-term plan to provide funds for us when we reach a specific age. It is handled quite differently [from a savings account] and has severe tax consequences for early withdrawals.

4. It is not recommended to use an account with appreciating value to pay out debt that is a depreciating value. In other words, you would not want to obtain a home [equity] line of credit to pay off your debt, since you would be placing your home (appreciating value) in a vulnerable position to pay off debt (money already spent/depreciating value).

Look to other sources to pay off your existing debt. Can you take on another part-time job? What do you have around the house that you could sell? Have you creatively considered other forms of current financial outlay that could be directed toward debt? Do you really need all those cable channels, or that expensive Internet connection? Look at ways you spend your money and see where you can cut your expenses. Do you purchase a $4 cup of coffee every morning? Do you eat meals out during the month?

Cutting costs is a challenge, but one that we must embrace to bring us out of debt. We should not look to our retirement plans as a source to pay off existing debt, since the consequences do not outweigh the gain.
Michael A. Masiello:
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Don't do it. It's better to pay down your debts a little each week than to take money from your retirement account. I know the temptation, but from many client experiences, this doesn't fix the problem. All of a sudden another "emergency" or financial issue comes up, and once again the retirement account is used as the solution. It becomes a little like an addiction, and before you know it, the account is gone. I urge you not to take money from this account.