Retirement plan decisions made easy
Drill Down: Good Reasons to Borrow from Your 401k
Have you caught a skeptical tone in my voice about 401k loans? I don’t much care for them, but at times it is the best choice.
Here’s a situation where the 401k loan is perfect. Your car’s transmission is making very bad noises, and you’ll need to lay out $2,000 to get it running again. You need your car to get to work and keep your job, let’s say. I further assume that you have a large enough credit limit on your credit card that you could pay for the transmission that way, but the interest rate would be 20 percent or more.
In this situation, go ahead and borrow from you 401k. (It may take a while to process the loan, though, so start the process now.) If your car is ready before the loan is processed, go ahead and put the repair on your credit card. When the 401k loan comes through, use that to pay the credit card bill.
Why is this an appropriate use for a 401k loan? First, it’s borrowing with a good purpose. If, instead of maintaining the transportation that enables you to work, you had asked about a vacation to Hawaii, I would have said do without. Buy a tent at a yard sale and go camping. Do something that you can afford. But in this case, keeping your job is always a high priority.
The second factor that makes this a good time to use the 401k loan is that you have credit available if you need to pay off the loan. So if you get a great new job offer before you’ve repaid the 401k loan, here’s what you do. Use your credit card account to pay off the loan. (Use one of the checks that your credit card company sends you.) That way there are no taxes or penalties for early withdrawal due to the IRS. You will have to pay a high interest rate, but that’s better than paying tax and penalty.
Bill Says: You may have an idea for something not quite so straightforward as either the car repair example or the Hawaiian vacation. Let me give you my general advice: You have to get your spending under control because you cannot spend more than you earn. Debt can let you do that temporarily, but it the long run you will be poorer because of it.
What are some other good examples of borrowing from your 401k? I can’t think of too many. If the spending is exceptionally prudent, such as a young family that would save money by owning a washer and dryer rather than going to the laundromat, then I’ll give you a pass. For the most part though, get by on what you earn and don’t borrow. Don’t believe that because you are borrowing from your 401k you are less in debt than if you were to borrow from a bank.
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Lesson 1: What the Heck is a 401k, and What’s So Great About It?
Lesson 2: Contributions to Your 401k
Lesson 3: Investments “Cook Book” Approach
Lesson 4: Investments: How Investments Work
» Lesson 5: Loans and Hardship Withdrawals from Your 401k
Lesson 9: Your 401k, Your Other Assets, and Your Life
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