Down Payment for Buying a Home
This topic may seem logical on the surface, as you are transferring money from one investment to another, assuming the value of the home increases while you own it. But this actually means you have two mortgages: one on the home and another on your retirement. In the worst-case scenario, you may have to sell the home to finance your retirement.
Child’s Wedding or Lifestyle Upgrades
This reflects the current mindset toward money, which is to live for the moment. It doesn’t make sense to spend $20,000 from your retirement egg on an event that lasts one day, a new car, or home renovations. You may create some wonderful memories or enjoy your new closets, but the consequences will be significant and lasting.
College Costs
You can borrow money to pay for college expenses, but you can’t take a loan to finance your retirement. Work with your developing student to find alternative ways to cover college costs. While a college education is a great gift to your children, having enough retirement savings so that they don’t have to support you too is also a wonderful gift. If you are compelled to pay for your children’s education, there are better ways to balance paying for your child’s education and saving for retirement.
Consequences of Borrowing from Your 401(k) Account
Before borrowing from your 401(k) account, understand the true cost and risks involved. Withdrawing a significant amount of cash from your account can affect you in several ways.
First, it reduces your retirement egg. Second, you miss out on the opportunity to earn compound interest that those savings could accrue. This could be a substantial amount if you borrow a large sum for several years.
Third, some 401(k) plans do not allow you to contribute until you pay off any outstanding loans. This puts your tax-advantaged retirement savings strategy on hold.
Note: There are conditions for 401(k) loans set by the IRS. You need to ensure you understand and plan for them.
Finally, if you lose your job while you have an outstanding loan, you will have to repay the loan in a very short timeframe or possibly face early withdrawal taxes unless you meet certain conditions. You will need to meet all of these conditions to avoid penalties:
- The loan must be a legal agreement, must be a secured loan with interest, and must have a repayment schedule.
- The loan amount is determined by the lesser of – 50% of the account balance or $50,000.
- The terms of the loan must specify the ability to make at least quarterly scheduled payments.
- An exception may be granted for a leave of absence, allowing payments to be suspended for up to a year as long as the repayment period is not changed and payments are increased to meet the repayment schedule.
Borrow Only in Emergencies
Avoid 401(k) loans unless there is a genuine and urgent emergency. Consider your automatic contributions to the fund as money gone forever (it will be a nice surprise when you retire). Create an emergency fund sufficient to cover living expenses for six months to deal with unexpected situations. Save for large purchases like homes, cars, and weddings. In short, you should not allow your current desires to outweigh your future needs.
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Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and ensure the accuracy, reliability, and quality of our content.
IRS. “401(k) Plan Fix-It Guide – Participant Loans Do Not Comply with Plan Document Requirements and Section 72(p) of the Internal Revenue Code.”
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