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Hello everyone and welcome to another episode of EricksonTV. Curtis here with Lauren. We
talk about a lot of different topics and one of our main objectives is to help people get
on the proper path to retirement. So there was an article in Tuesday's USA Today newspaper
about taking a loan out of a 401(k). What was shocking to me was how many people have
taken out 401(k) loans. Because the whole idea of a 401(k) is to put money away in pretax
generally, into a retirement plan that will grow for a future retirement benefit. As of
right now 1 in 5 401(k) plan participants, or 20%, have an outstanding loan, which is
a big number. Of those people 50% of the borrowers have taken out a loan more than one time.
They mention some specific things. Like 10% of those borrowers end up having to declare
a hardship withdrawal because they can't pay it back.
Without going into too much detail, generally when you take out a 401(k) loan it's capped
at half of your balance or $50,000. And you have to pay it back within 5 years at a stated
interest rate usually in the 4.5 to 5.5% range. I realize we had a difficult economy and we're still getting
through that; there are a lot of people that maybe had bad financial situations. But that's
the 401(k) plan not working as it should be. No way should 20% of 401(k) participants currently
have a loan outstanding.
What happened was basically we realized that pensions were going to be a problem. Especially
in the corporate world they realized they were not doing a good job of predicting them
and there was with incentives. People had an incentive and promised these payments but
weren't really able to pay them. So they said they'll have defined contribution plans. But
they are not just supposed to be savings plans. They are supposed to be very, very long-term
plans that are kind of going to replace pensions. If so many people are taking loans out to
get by day to day in the early years then these things are not working as replacements
for pensions.
There are some takeaways from this. One of them is that it's a really bad idea to take
out 401(k) loans to pay off credit card debt. That's the number one. They say a lot of people
go and charge up their credit cards. Some people think this is a good idea but never
borrow from a 401(k) for either your or your kids' college costs. It's probably better
to take a student loan and work out a system to have your child to take some ownership
of that loan. They also say there's that missed opportunity cost. If you take the money even
if you pay it back over 5 years, you've missed that potential market gain, that opportunity
cost which could be a big devastation on your retirement.
Last but not least, there is this advisor that I have to comment on because it really
bothers me. He thinks it's a bad idea if there is a stock market rally, when really it shouldn't
matter whether it's in a good market or a bad market. The other thing he says is that
"It's silly that anyone says it's always a bad idea to borrow money from your 401(k).
It comes down to discipline. If you are a very disciplined individual and stick with
terms and conditions of the loan, it is fine." He also says he has clients that borrow from
their retirement savings to use it for early business growth and he thinks that's a good
reason to do it. I just don't know if I like that kind of advice. The overpowering majority
of people that are very disciplined won't need to be borrowing from their 401(k) plans.
So I'm just having a hard time imagining there are very many people to whom that advice applies.
I understand if it becomes the last resort. But I could almost predict, and I'm sure you'd
agree with this, that down the road when you retire and start taking money out of your
401(k), if you have had some 401(k) loans in the past you will probably have some regrets.
Because you'll see that has a meaningful impact on how far your 401(k) has grown. There is
almost always a better option. Thank you for watching this episode of EricksonTV. We'll
see you next time.