As the economy goes through a prolonged rough patch, some of those who are worst hit are looking for creative ways to provide additional cash-flow into their lives to help stabilize their financial situation. Some of them might have lost a job, others might be facing foreclosure and some are probably just facing huge piles of consume debt.
In response to these negative situations, some people have chosen to try to work extra jobs to generate extra income. Others have opted to sell some of their assets such as cars, boats, and maybe even their home. Both of these options are good solutions since they involve sacrifice, will reduce one’s total amount of debt, and thus minimize the amount of liabilities that they have. Others are unwilling to sacrifice, so they attempt to borrow money wherever they can to continue to finance lifestyles they can no longer afford.
Many people in these situations have been turned down by banks for personal loans, so instead they turn to their 401K plan or other retirement plan and borrow money from that. This is not a winning game plan. Some 401K plans make it so easy to borrow against your investments that they will actually mail you out a debit card that will allow you to spend borrowed money against your 401(K) plan.
There are several problems with doing his. You’re sabotaging your future, because the money that’s no longer in your account because you borrowed it away isn’t earning interest. A year or two’s worth of interest on a few thousand dollars might not be the end of the world, but compounded over the next 30 to 40 years, and we’re talking about several hundred thousands of dollars.
The second problem with this is that you’re paying back a pre-tax account with after-tax dollars, and then when you retire, that same money will be taxed again. By borrowing money against your 401K plan, you’re volunteering to pay taxes on the same dollars twice.
Finally, if you were to leave the current job that you are in, you would be required to pay back the entire amount of the loan within 60 to 90 days, whether or not the company fired you or if you opted to quit and go work somewhere else. The last time you want to have a several-thousand dollar bill come in is right after you lose a job.
Borrowing money against your 401K plan is simply not a good way to bring extra money into your life. You’re not really creating any wealth because you have to pay that money back later. You’re also losing out on the interest that money would have been making and are volunteering to pay tax on that money twice! No Thanks!