Taking a Loan from My 401(k)? I Don’t Think So!
Lewis Schiff, author of The Armchair Millionaire, addresses 401(k)
loans in a recent CNN Money article. I understand the temptation to do it, but I don't think it's a good idea at all.
My main problem is that 401(k) loans are taxed twice. True
enough, you contribute to your 401(k) with pre-tax dollars. If you take a loan on it, you have to repay it with after-tax dollars, this is the first time that it is taxed. You get taxed the second time on your 401(k) plan when it's time to withdraw the money during retirement. Sure, you pay yourself the interest, but you're probably better off letting your money stay put and continue growing in the first place. As Suze Orman said on her New York stop on her book tour, "why do you think the government lets you do it?"
My 401(k) account is where the bulk of my net worth is located. I've taken a few precautionary measures to make sure I don't have to withdraw it prematurely.
1) I have an emergency savings of three months worth of basic living expenses. My favorite financial planner recommends 8 months. I am young, have no dependents, and feel like I can take that sort of a risk.
2) I have a Roth IRA, and I can always withdraw the principal at any time in the event I needed to do so.
3) I have both short term and long term disability insurance, paid fully courtesy of my generous employer.
4) In an extreme emergency, I could live on my credit cards until I found an income replacement. Because I've kept my FICO score high, I have very low interest rates on my credit cards.
In general, there seems to be a lot of confusion on what types of retirement plans have which features. Here are the best and most reputable summaries I could find.
For Bankrate's summary, click here.
The Fool also has a good reference guide/overview.
loans in a recent CNN Money article. I understand the temptation to do it, but I don't think it's a good idea at all.
My main problem is that 401(k) loans are taxed twice. True
enough, you contribute to your 401(k) with pre-tax dollars. If you take a loan on it, you have to repay it with after-tax dollars, this is the first time that it is taxed. You get taxed the second time on your 401(k) plan when it's time to withdraw the money during retirement. Sure, you pay yourself the interest, but you're probably better off letting your money stay put and continue growing in the first place. As Suze Orman said on her New York stop on her book tour, "why do you think the government lets you do it?"
My 401(k) account is where the bulk of my net worth is located. I've taken a few precautionary measures to make sure I don't have to withdraw it prematurely.
1) I have an emergency savings of three months worth of basic living expenses. My favorite financial planner recommends 8 months. I am young, have no dependents, and feel like I can take that sort of a risk.
2) I have a Roth IRA, and I can always withdraw the principal at any time in the event I needed to do so.
3) I have both short term and long term disability insurance, paid fully courtesy of my generous employer.
4) In an extreme emergency, I could live on my credit cards until I found an income replacement. Because I've kept my FICO score high, I have very low interest rates on my credit cards.
In general, there seems to be a lot of confusion on what types of retirement plans have which features. Here are the best and most reputable summaries I could find.
For Bankrate's summary, click here.
The Fool also has a good reference guide/overview.
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