The Boulevard to Financial Independence

By Mariette

Yesterday’s Chicago Tribune reported that more and more cash-strapped Americans are borrowing or taking hardship withdrawals from their 401k’s. There are numerous reasons why someone may consider doing this: paying a down payment on a first home, unexpected medical expenses, prevention of foreclosure on an existing home, paying off creditors, etc. However, except in truly desperate instances this is a very bad idea, for a number of reasons.

Not only do you get taxed twice on the money, once when you pay it back into your account using after-tax dollars, and again when you withdraw it during retirement, but if you leave your job for any reason you are required to pay back the loan within 90 days, and if you don’t pay the loan on time there is a 10% penalty. So in the end you are potentially paying a lot of money for this loan, loan shark rates in fact. And if that isn’t bad enough, you also lose the compound interest you would have earned. So you should ask yourself, is it really worth it? Is that really the best way to handle your financial difficulties or the purchasing of a mortgage or are you just robbing from Peter to pay Paul?

Drawing early from your 401k plan should be a last resort loan solution. You should be very desperate before turning to this as an option, “they are going to foreclose on my home” or “I lost everything in Hurricane Katrina, my insurance won’t cover it and the government money isn’t coming through” desperate.

If on the other hand, you are viewing your 401k as an easy bank in order to supplement your lifestyle or to put a down payment on a house then I would suggest that it might be a good idea to re-analyze your spending priorities (remember, loan shark rates,) even if that means postponing your house purchase until you have saved the money for it. That usually involves creating and adhering to a budget and re-prioritizing some of your spending, something which is not easy for many Americans to do and does in fact seem to run counter to our consumption-based culture. But it is almost always better than borrowing from your future to pay for a present that you cannot afford. The advantage is that in the end you will be continuing to build your retirement fund as well as spending your money on things that are really important to you rather than frittering it away on things that you don’t really need or care about.

I was forced to do this myself recently. I had saved money so that I could quit my job and move across the country, but due to health reasons I had to wait three months before looking for a new job, which whittled my savings down to almost nothing. I had considered cashing in some of my 401k in order to hold me over until I was employed again, but after I did the math I realized what I poor idea that would be. It would have meant a continuation of my borrowing from the future to pay for a present that I couldn’t afford pattern, which had got me into the debt cycle in the first place and had me stressed out financially.

A better solution would be to drastically scale back my spending to the bare minimum, and find any job I could so I would have money coming back in as soon as possible. I managed to find a couple of part-time jobs and have now found a full-time job as well. This re-evaluation of my financial priorities has given me a renewed commitment to living completely within my means and getting out of debt. This includes improving my cash flow through working two jobs for the time being, careful budgeting of my money and living frugally, so that I can pay off my debt, rebuild my emergency savings, and continue to make contributions to my, thankfully still intact, 401k.

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