Borrow from Your 401(k)? No Way!

07/21/2008 12:00 am EST

Focus: MARKETS

Terry Savage

Author, The Savage Truth on Money

Today MoneyShow.com launches the SavageMoney Blog, a brand-new blog from one of the nation's leading experts on personal finance. Terry Savage, an award-winning writer, speaker, and television personality, will give her unique take on critical issues affecting your finances, including retirement, investing, health care, taxes, and estate planning. And you can join the conversation with comments and questions that Terry will answer throughout the week. Visit the SavageMoney Blog every Monday on MoneyShow.com and have your say!

Have you considered dipping into your retirement fund to tide you through rough times? Stop.  That would be a huge mistake—even if you only “borrow” the money, intending to repay it to avoid taxes and penalties.

Your nest egg may be tempting, though. A new study by The Center for American Progress shows that more workers are tapping their retirement funds and borrowing more money from them. The latest figures are from 2004, when workers had $31 billion in outstanding 40l(k) loans.  That was a sharp increase from the $6 billion in loans outstanding in 1989. 

And that borrowing came before the current credit crunch, housing meltdown, and rising oil prices that have people scrambling for extra cash.

We all know that withdrawing money from a retirement plan has huge costs—a 10% penalty if you’re under age 59 1/2, and ordinary income taxes. But somehow it seems easier to convince yourself it’s worthwhile if you’re only “borrowing.” Big mistake!

When you borrow money from your 40l(k) or 403(b) plan, you lose all the potential growth that could have come if that money had continued to be invested. The survey showed a $5,000 loan could cut retirement savings by 22%—even if the loan is repaid without penalty. That assumes the person earns $40,000 a year and is five years into a 35- year career.

Put it another way: Suppose you invested $5,000 in your 40l(k) or IRA, and it grew at historic average rates slightly above 10%. In 30 years you’d have more than $125,000 in your account.  But if you’d taken that money out of your retirement plan, that’s money you wouldn’t have at retirement!

Is it worth using that $5,000 today if it deprives you of so much money later, when you’ll need it even more? And when you’re retired, it’s hard to earn back what you’ve lost.

MoneyShow.com users know the answer! And if you’re even thinking of making such a move, this free calculatorfrom the National Center for Policy Analysis will tell you how much it will really cost you.

But have you discussed this with your adult children, or co-workers? It’s worth talking about—and we’d like to hear your questions and opinions, too.

Let’s begin the conversation!

Terry Savage is personal finance editor of MoneyShow.com. The opinions expressed here are her own and do not necessarily reflect the views of InterShow.

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