January 27, 2010

My version of the Rapunzel story has my very pregnant wife unable to bear the August heat and yearning for a little cool breeze. Fortunately our baby didn't get locked up in a tower by a witch. I borrowed from my 401(k) and installed air conditioning. Everyone needs a little cash from time to time - a loan from your 401(k) or 403(b) can be a source.

A loan provision is a critical element in enticing young people to do something good for their own future: save. The average newly minted college graduate has plenty of things to spend money on between picking up her diploma and retiring: buying a car or house, vacations, marriage, school loans. It is easy to put off saving by thinking of your need for cash. But if you must borrow, consider a few important things:

  1. Borrowing results in a withdrawal of cash from your account. You are borrowing your own money, so it is liquidated from your plan balance and paid to you. You will not earn any return on that money until it is paid back, so if markets rise you will miss out. But if markets fall, you'll look like a genius. You'll never know what the market will do so don't sweat it.
  2. It may be your money, but you must pay yourself back. If you stop making payments for any reason (you lose your job, for example) then your loan is in default and while there's no need to send yourself dunning notices, the IRS considers default a taxable event and you will pay income tax and a 10% penalty on the unpaid amount. Ouch.
  3. You can borrow half of your account balance up to $50,000 maximum and must pay it back over no more than 5 years (longer if your loan is for a home purchase). Make sure the monthly payments won't sap your paycheck.
  4. Be sensible: borrowing to pay off credit card can be wise, but don't do it unless you have the discipline not to run those card balances back up.

A loan against your retirement savings is convenient and inexpensive, but think of it like any other debt - avoid if possible and be sensible if you must borrow.

Tomorrow: Ground Rule #5: Stay Away

GTC

 

(This article contains the current opinions of the author but not necessarily those of Brighton Securities Corp. The author's opinions are subject to change without notice. This blog post is for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities).