In today’s “Money Mondays” segment, Mellody Hobson answers “Text Tom” questions about retirement.
This first one is more specific but it’s great. A listener texted that federal employees can borrow from their 401(k) plans for a one-time fee of $50. The interest and payment of the loan goes back to the employee because they’re borrowing from the money they contributed. Then the listener asks, “Is this not advisable?”
I have to love this listener because he or she clearly already knows what I’m going to say. First, they try to rationalize borrowing from their retirement by pointing out the low one-time $50 fee, then he or she further pitches the idea by qualifying that the interest and payment of the loan goes back to the employee, and finally the listener doesn’t ask “Is this advisable?” but rather, “Is this NOT advisable?” That makes me smile. The short answer is no, it is not advisable.
Here’s why: First, any money you take out of your 401(k) plan is money that’s NOT working toward a more secure retirement for you. Yes, the interest rate of the loan is generally lower than a commercial one and you’re paying yourself back as opposed to a bank, but your retirement money is money you can’t afford to lend to anyone—including yourself. Withdrawing money early means missing out on long-term appreciation. And that money is sure to trump any money you’d save short-term by getting a lower interest loan. And compound that missed opportunity if your plan is in the majority that won’t allow contributions until the loan balance is repaid. In addition, you’re paying yourself back with AFTER-tax money. Say you’re in the 20% tax bracket—that means earning a dollar only gives you eighty cents toward repaying the loan, and that money will be taxed AGAIN when you withdraw it for retirement.
That one-time $50 fee is misleading.
The whole point of a 401(k) plan is it allows you to save money on a tax-deferred basis, but if you borrow from it, you end up paying taxes on that money TWICE!