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Debt sucks, but screwing over my future just to pay for my past decisions doesn’t seem all that wise either.
I have come a long way in my journey to being financially educated. While I still have a long way to go, one thing I’ve learned is that borrowing money is to be avoided at all costs.
Currently, the money I’ve borrowed would if I stuck to the plan keep me in debt into my 50’s. However, I’m going to do my best to pay off me debt early and to set my future self up for success by taking advantage of my 401(k).
The reason paying off my debt will take so long is because I’m not just paying back the money I borrowed I’m paying it back with lots and lots of interest. If you looked at my Debt Journey, you would have noticed that my student loan balance is over $230k. When I finished school, it was $193k.
1. My 401(k) Belongs to Future Me
Even with my debt, I do have a 401k, I contribute enough for my company match and no more. Given my economic realities, I’m in no position to turn down free money.
The amount has built up, enough that by the end of the summerif I were to use it I’d be able to start turning the tide on my student loan balance this year. However, I won’t be doing it, because the money isn’t really mine. It belongs to future Liz.
Future Liz is going to be needing that money. If I were to borrow that money, I’d not only have to pay it back but with interest too.
See I’m hoping that the interest on my 401k will work in my favor (that is generally how it works). Borrowing against it will hurt more than help me. Plus it will really piss future Liz off (trust me).
I don’t like being mad at myself. I’m already plenty mad at myself for the damage I’ve already done androbbing future Liz to pay past Liz isn’t going to solve any problems. So I’ll keep contributing to future Liz, while I work my ass off to pay for past Liz’s mistakes. I will also now stop talking about myself in the third person. You’re welcome.
2. There Are Penalties for Withdrawing From Your 401(k) Early
Since my contribution to my 401(k) is pre-tax, withdrawing before I’m 59.5 means I will have to pay both state and federal income taxes. Additionally, I’ll have to pay a 10% early withdrawal penalty.
For example, if I were to take out $10k from my 401(k) after taxes and the penalty I end up with about $7,000 (approximate, taxes may vary). Alternatively, if I keep that $10k in my 401(k) It will earn interest on average of 4-7% each year. So in 5 years, assuming it earns at an interest rate of 4% it would total $12,166.
3. My 401(k) Is Regularly Increasing My Net Worth
Since I have so much debt, I actually have a negative Net Worth. However, by regularly contributing to my 401(k) I’m helping to increase my Net Worth. As a bonus, my 401(k) is earning interest that also adds to my total Net Worth.
I have the contributions pulled directly from my paycheck, so I can consistently grow my net worth without ever having to think about it.
Now I wouldn’t suggest you go on complete autopilot. Make sure you understand the vesting schedule of your 401(k) as well as any employer match increases. After three years my employer increases theirmatch, however in order to take advantage I had to increase my contribution.
Wrapping it Up with a Bow on Top
Your 401(k) is money that you have wisely set aside for your future. If you are in debt then you know how much it sucks when you don’t have enough money for all the things you want. Do you really want to screw over your future self by borrowing or withdrawing from your 401(k) early? No.
In case you need more convincing, here are three reasons why you should never borrow from your 401(k):
- It belongs to future you
- There are penalties for withdrawing from your 401(k) early
- Your 401(k) helps to increase your net worth
What are your reasons for keeping your retirement money where it is at?
FAQs
As much as you may need the money now, by taking a distribution or borrowing from your retirement funds, you're interrupting the potential for the funds in your 401(k) plan account to grow through tax-deferred compounding — and that could make it more difficult for you to reach your retirement goals, says Feist.
What are the disadvantages of borrowing from a 401k? ›
3 Reasons Not to Borrow From Your 401k
- You're missing out on investment growth. When you reduce the balance of your 401(k) account, you have less money growing along with potential gains in the market. ...
- It's another monthly expense. ...
- You're risking a balloon payment situation that could lead to expensive consequences.
Common arguments against taking a loan include a negative impact on investment performance, tax inefficiency, and that leaving a job with an unpaid loan will have undesirable consequences. If you don't want to tap into your retirement savings for money, you can always look into borrowing a personal loan.
Is it smart to borrow from a 401k to pay off debt? ›
If you have a high-interest debt, such as from a credit card with a big balance, you may get a much lower interest rate on a 401(k) loan. If you have upcoming debt payments and no other alternatives for paying them, borrowing from your 401(k) can reduce fees and penalties.
Why you shouldn't cash out your 401k? ›
Withdrawing money early from your 401(k)—that is, before you turn 59½—comes fraught with financial risks. It's universally considered a bad idea to prematurely siphon funds from a nest egg that can help support your lifestyle in retirement or protect you in your senior years from the high cost of healthcare.
What are three disadvantages of 401k accounts? ›
There are, however, some challenges with a 401(k) plan.
- Most plans have limited flexibility as it relates to quality and quantity of investment options.
- Fees can be high especially in smaller company plans.
- There can be early withdrawal penalties equal to 10% of the amount withdrawn before age 59 1/2.
Answer and Explanation:
The disadvantages of borrowing is money is that debt results in tying up future funds in order to pay back the debt and pay interest on the privilege of using that financing.
What are the advantages and disadvantages of borrowing? ›
Borrowing money allows you to support aspects of your business which you may not be able to afford. Yet even if you do have the good fortune of possessing sufficient capital, parting with your savings could cause issues later in your business' development and limit your ability to build a reputable credit rating.
What are the disadvantages of borrowing to invest? ›
Borrowing to invest, also known as gearing or leverage, is a risky business. While you get bigger returns when markets go up, it leads to larger losses when markets fall. You still have to repay the investment loan and interest, even if your investment falls in value.
Why are you better off not borrowing? ›
Studies show that such debt is correlated with stress. The size of the debt also matters: Unhappiness and burnout are higher when student loans are larger. Again, this is very likely because carrying the debt inhibits the satisfaction of making progress toward financial freedom and security.
The unfortunate truth is that 401(k) plans come with high management fees. This eats into your earnings in the long run. These fees are oftentimes hidden among legal jargon, according to the Rich Dad team. Fees can be but aren't limited to transaction fees, legal fees and bookkeeping fees.
Is it a good idea to borrow from your 401k to buy a home? ›
Taking money out of your 401(k) to buy a house robs you of compound growth and is never a good idea. There are two ways to buy a house using money from a 401(k): early withdrawal or a loan. Early 401(k) withdrawals come with penalty fees and taxes if you're younger than age 59 1/2.
What is the downside of borrowing from 401k? ›
Risks of taking out a 401(k) loan
“If you leave your job, or are no longer employed with that company, you will be forced to pay the full balance of the loan back, and if you can't do that, whatever you can't pay back, you'll be subject to the taxes because it will count as an early distribution plus a 10% penalty.”
Is it better to have a 401k or debt free? ›
If the interest rate on your debt is 6% or greater, you should generally pay down debt before investing additional dollars toward retirement. This guideline assumes that you've already put away some emergency savings, you've fully captured any employer match, and you've paid off any credit card debt.
At what age is 401k withdrawal tax free? ›
Once you reach 59½, you can take distributions from your 401(k) plan without being subject to the 10% penalty. However, that doesn't mean there are no consequences. All withdrawals from your 401(k), even those taken after age 59½, are subject to ordinary income taxes.
Is taking a loan out of a 401k bad? ›
Risks of taking out a 401(k) loan
“If you leave your job, or are no longer employed with that company, you will be forced to pay the full balance of the loan back, and if you can't do that, whatever you can't pay back, you'll be subject to the taxes because it will count as an early distribution plus a 10% penalty.”
How do I avoid 20% tax on my 401k withdrawal? ›
Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.
