borrowing from my 401k to pay off debt?

Question

How smart or how stupid is it to borrow from my 401 to pay off debts..it will be about $10,000.00... For the record, I have my max going into IT each week as it is. but we are expecting our first child and we have learned our lesson with our stupid spending. Our credit has suffered for past mistakes, and we now need to clear it all up and get into shape. Opinions...input..have you done this before? how does it work? what are your experiences? was it a good choice, would you do it again if you had to? Thanks in advance.

Again, our credit is terrible because or irrisponsible mistakes in the past. Therefore...opening another credit car to consolidate is not an option, and our bank wont even consolidate for us, because we have too much open credit.....
please no judgements, its a problem that we are aware we created ourselves and we know we messed up.

for the record, I DO pay my bills, just 90% of the time they are late. because we are trying to catch up. I know the importance of paying them..its just I can only pay it when the money is there.

Answer 1

All of the experts will have a vested interest in the opinion provided to you. Most will say, "DON'T DO IT!!!" Some of the reasons provided will be very valid, while others will not. Just know that the answers will be biased in some form or fashion. For instance, your employer and personal financial advisors will state, "Don't do it". Why? Well, one main reason is that that money will no longer be there for them to manage. They just won't tell you that. Here are my opinions and I hope I am unbiased.

1. A 401k loan ties you into a current work arrangement with your employer if you have no other means of paying off the debt. If you quit, that money will have to be repaid or it will be treated as an early withdraw and subject to penalties.
2. Contributions made into the plan are pre-tax - payments on a loan are after tax. I think this is very important if you are in the higher tax brackets, but I think it is overplayed.
3. You have a smaller base to work off of. So a 10% increase on $25K invested is more than a 10% increase on $15K if you take out a loan. Once again, several things play into this assumption. How old are you? Are you pulling $10K out of $100K, or are you pulling $10K out of $20K? (most places have a 50% loan limit). Also, what other sources of income do you have?

Overall, the younger you are, the more you can play with the system and recover. However, if you believe the BS that you need $X to retire, and need to invest $Y to get there, then God help you.

It is my own personal opinion that those younger than 35 are just investing in the market to support the lazy and greedy babyboomers that will ultimately enjoy all of the surplus and leave the younger generations to work until the day they die. Just imagine if the younger generations felt this way and pulled $$$ out of 401k accounts. The system would take a beating.

So, in the end, do what is best for you and your family. But for me, #1 on the list is a major hurdle.

One more thing that cannot be determined by math. There is a huge psychological benefit in knowing that you have one bill to pay a month instead of dozens.

Answer 2

It can be very beneficial. Most employers allow you to take a loan against your 401K up to a certain amount or certain percentage. You then pay back the loan at a certain interest rate; usually lower than to a financial institution. You are in effect paying the interest to yourself, i.e. your 401K, instead of to a lender. This interest becomes the return on that portion of your 401K. It may be better or worse than the return of other investments in your 401K

If you do this though, you must positively pay it back on schedule. If you default on it, the IRS will consider it an early distribution instead of a loan; and income taxes will be due on it for that year. There will also be a 20% early distribution penalty if you are younger than 59 1/2 years old.

Answer 3

I would not do it under these circumstances. I would stop my contributions to my 401k and apply that and all other available funds to your debt. You can possibly incur penalties and horribly taxes if you step outside of the boundaries that govern retirement funds and their management. Borrowing in some cases is less of a concern than others, I would hate to see you borrow the money from your account and be penalized for not paying it back in the appropriate amount of time. I think there may be a very few cases in which you can borrow without having to repay but I don't think your case will be one of them. Go to daveramsey.com, he is a great common sense financial planner and has a radio show that you might even call in for his opinion. He looks at your whole situation to give advice and seems very thorough. Hope this helps, good luck.

Answer 4

Borrowing from your 401K can be an easy and cost effective way to gain credit if you are considered high risk. You will get a much better rate than you would from traditional lending companies. The one thing to be careful of is that you must pay the money back (Not judging you). If you fail to pay back this loan it will be reclassified as a distribution to you and you will have to pay income taxes as well as early distribution penalties on your tax return. You never want to take an early distribution.

Answer 5

I think it's generally a bad idea to borrow from your 401k. Just reduce your contribution to the max that your employer matches, consolodate your credit card debt and make your monthly payments. It's a long road ahead, but financially, that's the best way to go.