At Work

Your 401k is not …

A piggy bank

An emergency fund

A savings account

A car loan source

A credit card

A vacation fund

Your 401k is your pension plan, your retirement fund, to be used only after you retire. The money you invest in your 401k should be thought of the same as your Social Security payroll taxes.

Just like with the taxes you pay, your 401k contributions should determine your standard of living based on your net take home pay and nothing more.

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12 replies »

  1. RD I will agree with what you say in principle, but I can give you one example where it can make sense to borrow from your 401K.

    In Feb 2015 my 30 year old son borrowed $10,000 from his 401K to have a new house built for $160,000, he worked with the builder on the lowest price possible and found out later that new homes by his builder, at his closing are now $190,000.
    Without the loan he would of stayed a renter. By the time he closed in Oct 2015 the house appraised for $175,000 and today it is worth $200,000.
    I knew the 401K loan would not be a problem for him as he was contributing $800 per month into his 401K, he has dropped it some since the home purchase increased his monthly housing expense, but still contributes 10% of his income plus the $167 loan repayment for a total of $667. Now if I could just get him to pay more on his mortgage to save on those interest payments.

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  2. Wrong, wrong, wrong.

    Two thirds of America’s workers live payday to payday – for example, according to the American Payroll Association’s annual survey, Getting Paid in America, 70+% of the 30,000+ workers surveyed admitted that they would have some or significant difficulty if their next paycheck was DELAYED one week. Not MISSED, just DELAYED, and DELAYED ONLY ONE WEEK!

    Despite that, in the same survey, 86+% of workers who have access to an employer-sponsored savings plan (e.g., a 401(k)) contribute to the plan. Good for them.

    If you remove all liquidity from the 401(k) plan, workers will only save what they are certain they can afford to earmark, to lock up until reaching retirement age (ages 65 – 70 these days). Try telling a 25 year old that she needs to save 15% – 20% of her current income and salt it away for 40, 45 or 50 years.

    The #1 problem with regard to “leakage” is that too many plans allow hardship withdrawals, and the idiots within the beltway just made it easier to take a hardship withdrawal (eliminating the six month suspension, eliminate the requirement you take a loan first, etc.)

    The #2 problem with regard to “leakage” is that plan sponsors allow service providers to use 20th Century loan processes, which trigger leakage at separation almost everytime there is a loan outstanding. Plan Sponsors should all push service providers to adopt 21st Century technology, electronic banking, ACH processing so that not only could loan payments continue to be made after separation, but a participant could initiative a loan (avoid leakage and premature distribution penalty taxes from a distribution) prior to age 59 1/2 but after separating from service.

    Many studies show that liquidity is a key element to getting many individuals to participate, and to get others to contribute more than they believe they can afford to earmark for retirement.

    So, sure, those who have retirement preparation as a priority and who also have substantial disposable income can afford to avoid treating their 401(k) as a piggy bank, an emergency fund, a savings account, a car loan source, a credit card and/or a vacation fund. The rest of us are not in that position.

    And, many of us in that position today remember when we were scraping by. Sounds like a case of egocentric bias.

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    • Regardless, that is not what the 401k should be used for. If the plan was defined benefit and the worker contributed there would be no access or shouldn’t be.

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      • What a 401k should be? Says who? Must it only be focused on retirement, and nothing else?

        If marketed that way, that is one reason why people don’t start early enough or save enough- retirement isn’t a priority for most people in their 20’s or 30’s.

        With respect to DB pensions, nothing wrong with plan loans there either. The difference is that the interest you pay to the plan most likely won’t be credited to your own accrued benefit.

        From a participant household wealth perspective, so long as you treat the loan as the fixed income asset it is, and adjust to your target allocation, and so long as the interest rate you pay to yourself is less than the rate in your credit card, payday loan or other commercial source of liquidity, a plan loan increases household wealth.

        Can’t be used inappropriately, but done right, liquidity through plan loans will generally increase not only household wealth, but retirement account assets as well – as people will save more than they would otherwise earmark for retirement, to take full advantage of the employer match and tax advantages while maintaining access through liquidity.

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      • Disagree with your view on this. What about people who stop saving or reduce saving during period of loan because they can’t pay both? I think it causes a wrong mindset to view 401k as anything other than a retirement plan. In NJ state workers take DB loans by the thousands. At a time when the plan is underfunded the interest rate charged on the loan is 2% less than the assumed return on the fund investments.

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    • BenefitJack – That was the exact point of my comment. My Son and his family are way better off with a $10,000 loan from his 401K and a new house, not paying rent. Now with an asset that is worth $40,000 more than his 3 year old mortgage balance. Sometimes you have to look at the big picture and weigh the positive and negatives in every situation.

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      • That better off can’t really be assessed until retirement. I sure wouldn’t have wanted to retire with my only large asset being my home.

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      • RD get real – My son borrowing $10K from a 401K that had a balance of $40,000 in just 5 years with additional money being added each month and the loan being paid back over 5 years. His only asset at retirement is not going to be just his home. RD you cannot be right every time.

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      • RD – I guess you believe my son and his family would be better off renting at $750 per month rather than owning his home at $1,100 per month, just because he did not borrow from his 401K. Faulty logic on your part.

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      • Dick, in response to your later post, you ask:

        What about people who stop saving or reduce saving during period of loan because they can’t pay both? Do you think there would be more or fewer people who stop their contributions if they took a credit card advance or a payday loan – compared to a loan from the plan? We know the answer – they are much less likely to stop their contributions where the loan payments are less.

        In NJ state workers take DB loans by the thousands. At a time when the plan is underfunded the interest rate charged on the loan is 2% less than the assumed return on the fund investments. Well, when it comes to NJ public employees, and NJ politicians and state administrators, you can’t fix stupid.

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      • I hear you, but I still think our focus should be on promoting 401k as only pension plans only to be used for that purpose.

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      • JRATT – I totally understand what you are saying. The one and only time I took a loan from my 401K was to buy the lot next to mine. It doubled my lot and the property came with a two car garage. I could not even buy the materials to build the garage for the $13K I borrowed from myself. I looked at it as an investment toward my house. Real Estate sucks as an investment but for a mere 20% investment of my house’s original purchase price, I more than doubled the value of my property.

        I would never borrow for vacations, a second home, cars, a boat, or my kids college. I think maybe only for medical if there was no other way out and I was being charged interest for some reason on the bill. But none of that ever happen so I was lucky.

        I never reduced my contribution to my 401K but part of it was still being used to pay back the loan. I feel that by not stopping my contribution, there was zero chance of me not restarting. Also I was already contributing enough or in excess of the loan amount, that I was still getting my full company match, which if I stopped altogether would have been even more money that I would have lost. If I couldn’t get the “free money” from the company match, I would have passed on trying to buy the lot.

        Plus instead of two years of not raising my 401K balance by not contributing, my overall balance would increase each month by my loan repayment resulting in shares being bought back so I did not totally lose two years of compounding on all that money.

        By dumb luck, I had better returns than my peers because I was paying myself back with interest in what otherwise would have been a two down years for ROR because of market performance. I wouldn’t count on that for a good plan.

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