The Simple Dollar - Does it Make Sense to Take a 401(k) Loan?
We were recently quoted for a great article in The Simple Dollar: "Does it Ever Make Sense to Take a 401(k) Loan?"
For most, your 401(k) will become your largest account. Even with just a few years of diligent savings, maximizing your company match, and decent stock market returns can amount to a significant sum.
However, all too often those dollars slated for retirement are too tempting to tap for other uses. Whether it be a car, a home, a wedding, or another big expense, many savers find an excuse to raid their retirement fund early.
And almost always, this is a poor decision in the long run.
But is there ever a valid reason to take a loan out from your 401(k)? That's what we look into on The Simple Dollar. Here is an excerpt from the article, with a link to the full article below:
"Does It Ever Make Sense to Take Out a 401(k) Loan?
With all those downsides, you may be wondering if it ever makes sense to take out this type of loan. Matt Hylland, a financial planner at Hylland Capital Management in North Liberty, Iowa, says he can think of one specific instance where it could make sense — if you’re desperate to pay off high-interest debt.
Hylland notes that many credit card interest rates surge past 20% these days (the average credit card APR is over 17%), and a 401(k) loan could be a good option if you don’t have the credit or means to qualify for a balance transfer card or debt consolidation loan.
Hylland suggests taking the time to run the numbers to see whether a 401(k) loan would make sense to pay off your high-interest debt. Your first step, he says, is putting your current credit card payment into an online calculator to determine the total cost of carrying that debt. That will tell you how much you’ll pay to service your high-interest debt for the long haul.
For example, a $10,000 balance at 22% interest would likely come with minimum payments of around $283 per month. At that rate, it would take you five years to pay off your debt and you would pay about $6,257 in interest in the end.
If you took out a 401(k) loan to pay off that entire high-interest $10,000 balance today, you would pay a lot less than $6,257 in interest during your loan period. The exact rate of your 401(k) loan will vary depending on your plan, but rates tend to be just one or two percentage points above the prime rate, currently at 5% — significantly lower than 22%. Not only that, you’ll also be paying that interest back to yourself instead of to a bank, so you will recoup those interest payments in a roundabout way.
However, you would lose some growth from your investments, notes Hylland. How much you lose depends on how long you take to pay back the loan along with the growth rate of your 401(k) investments.
With that in mind, imagine you took three years to pay back the $10,000 401(k) loan. Assuming your investments would have grown at 7% during that time, and you pay back your 401(k) loan at 5% interest, the cost of this “loan” wouldn’t be too significant. “The lost earnings on your 401(k) investments is bad, but not nearly as bad as credit card interest payments,” says Hylland."
The entire article can be found here: https://www.thesimpledollar.com/does-it-ever-make-sense-to-get-a-401k-loan/
So in general, the answer to the question "Should I take a loan from my 401(k)?" - Is "No!"
But cases such as high-interest debt may be an exception.
We walk through how to calculate the best use of your money in the article above for those interested in doing it yourself. For the rest who need a hand determining the best way to allocate your retirement funds... That's what we do!