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Top 10 reasons you should never borrow from your 401(k) plan
When you need cash—not the 50 bucks you get from an ATM to tide you over for the day but, rather, $5,000 or $10,000 to handle an emergency—what asset or resource will you tap into to get it?
Historically, the answer to that question was a home-equity loan.
This was the normal course of action, because most people had built up lots of home equity. Prior to 2008, it was routine for many to discover that their houses had increased in value by 50 percent or more even if they had owned them only a decade or so.
DNY59 | iStock | 360 | Getty Images
Therefore, if someone needed $20,000 or $30,000 for an addition to the house, to help pay their children’s college tuition or to cover a medical bill, it was easy enough to tap into that equity. And with interest rates at historical lows, they could do it and still keep their mortgage payments steady.
Well, those days are long gone. It’s all thanks to the 2008 credit crisis, which caused many to lose their houses or watch their values plummet to the point that substantial home-equity loans were no longer so readily available.
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So if you need cash now, where are you looking to get it?
Unfortunately, retirement accounts have replaced the home-equity loan as the predominant source of cash today. They have become America’s new piggy bank.
We know this because the IRS collected $5.7 billion in penalties in 2011 for early withdrawals from 401(k) plans and other retirement accounts. (This is the latest data available.) The penalty for withdrawing before age 59½ is 10 percent, so this means that Americans in 2011 withdrew $57 billion from their retirement savings long before they were supposed to.
If you’re considering borrowing from your 401(k) retirement plan, you are most likely thinking: “What’s the harm? I’m just borrowing from myself.”
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Well, think again. Nothing could be further from the truth.
Borrowing from your retirement plan for any reason—no matter how serious that reason may seem to you—will hurt you in the long run. It’s a sure way to destroy your retirement savings and put you at risk of having a lot less money than you had planned for in your golden years.
Here are my top 10 reasons why you should never, ever borrow from your 401(k) plan:
A 2013 Fidelity study pointed to yet another danger: It found that, of 180,000 who took out 401(k) loans over the past 12 years, 66 percent took out more than one loan, 25 percent borrowed three or four times, and 20 percent did so five times or more. Thus, initial borrowing could put you in danger of becoming a repeated borrower, thereby causing even greater damage to your retirement savings.
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So for all these reasons, discipline yourself to avoid borrowing from your 401(k) retirement plan or any other workplace retirement plan—no matter how badly you need cash.
Find another way to get the money you need. By doing so, you’ll come to appreciate what a huge favor you did for yourself by allowing your account to grow without setbacks. And it will make for a more comfortable retirement.
—By Ric Edelman, special to CNBC.com. Edelman is founder and CEO of Edelman Financial Services.