Category: Retirement plans for Employees

8 Reasons To Never Borrow From Your 401(k)

Don’t use your retirement savings account as a piggy bank.

Did you know you can actually take out a loan from your 401(k) retirement plan if you want to? According to recent data, about 20% of those participating in a 401(k) plan borrow money against that savings account. You might be tempted to do the same in order to pay for a large or unplanned expense, but there are many reasons why you should avoid doing so at all costs.

Below are the eight major reasons why borrowing from your 401(k) is a bad move for your long-term financial future.

By Lisa Smith

Reason #1: You Are Not Saving

If you borrow money from your 401(k) plan, most plans have a provision that prohibits you from making additional contributions until the loan balance is repaid. Even if your plan doesn’t have this provision, it is unlikely that you can afford to make future contributions in addition to servicing the loan payment.

Because the whole point of having a 401(k) plan is to use it is as a way to save for the future, you are defeating the purpose of having this account if you use it before you retire.

Reason #2: You Are Losing Money

If you not are not making contributions, not only is the entire balance that you borrowed missing out on any potential growth in the stock or bond markets, but each future contribution that you are unable to make (since you have an outstanding loan) isn’t growing either.

The extraordinarily low interest rate that you are paying to yourself with your loan payment is likely to be a pittance in terms of return on investment when compared to the market appreciation that you are missing.

“It is common to assume that a 401(k) loan is effectively cost-free since the interest is paid back into the participant’s own 401(k) account. However, there is an ‘opportunity’ cost, equal to the lost growth on the borrowed funds. If a 401(k) account has a total return of 8% for a year in which funds have been borrowed, the cost on that loan is effectively 8%. This is an expensive loan,” says James B. Twining, CFP®, CEO and founder of Financial Plan, Inc., in Bellingham, Wash.

Of course, there’s also the fact that you are paying yourself back with after-tax money. If you are in the 25% tax bracket, earning $1 only gives you $0.75 toward repaying the loan, and that $0.75 will be taxed again when you retire and withdraw it from your plan. While the interest rate on the loan may be low, you are getting taken to the cleaners by its tax implications.

Reason #3: Time Will Work Against You

Long-term investing (such as saving for retirement) is based on the idea that by putting time to work on your behalf, your money will grow. Most calculations suggest that your money will double, on average, every eight years.

401(k) plans permit each loan to be held for up to five years or longer. Therefore, if the loan is used to fund a first-time home purchase, loan holders not only lose out on what should have been an opportunity to nearly double their money, but they are also left unable to make up for the lost contribution and growth opportunities.

Over time, their balance is unlikely to ever reach the total that it would have reached had contributions continued uninterrupted. (For more insight, check out Delay in Retirement Savings Costs More in the Long Run, Understanding the Time Value of Money and Is it easier to save for retirement if you start early in life?.)

Reason #4: If Your Financial Situation Deteriorates, You Could Lose Even More Money

Should you find yourself in a position where you are unable to repay the loan, it is treated as a withdrawal and the outstanding loan balance will be subject to current income taxes in addition to a 10% early withdrawal penalty if you are under age 59½. (For more on this, read Tough Times … Should You Dip into Your Qualified Plan?.)

However, there are several exceptions to the early withdrawal penalty, such as the post-55 exception. (For more on this, check out the IRS page on this topic.)

Reason #5: You Are Trapped

If you have an outstanding loan, most plans require that the loan be immediately repaid if you quit your job. “If you cannot repay the loan 60 days after losing your job, it will become fully taxable and may be subject to a 10% early withdrawal penalty,” says Carlos Dias Jr., wealth manager, Excel Tax & Wealth Group, Lake Mary, Fla.

That means as long as you have a loan you are stuck in your current job and may be forced to pass up a better opportunity should one come along. Or, you can take the loan balance as a withdrawal and pay the 10% penalty, which further compounds the growth opportunities that you have missed by taking the loan.

Reason #6: You Lose Your Cushion

Taking a loan from your 401(k) plan should only be done in the most dire circumstances after you have completely exhausted all other potential sources of funding. If you take money from your plan to fund a vacation or pay off higher interest loans, the money won’t be there to borrow if and when you really need it.

Reason #7: It Suggests That You Are Living Beyond Your Means

The need to borrow from your savings is a red flag – a warning that you are living beyond your means. When you can’t find a way to fund your lifestyle other than by taking money from your future, it’s time for a serious re-evaluation of your spending habits.

What purchase could possibly be so important that you are willing to put your future in jeopardy and go into debt in order to get it? (For more insight, see Digging Out of Personal Debt and The Beauty of Budgeting.)

Reason #8: It Violates The Golden Rule of Personal Finance

“Pay yourself first” is the golden rule of personal finance. Violating that rule is never a good idea.

The Bottom Line
If the idea of taking a loan from your 401(k) plan crosses your mind, stop and think before you act. Instead of short-changing your future to finance your lifestyle today, consider re-evaluating your current lifestyle instead.

Scaling back on your expenses will not only reduce the burden on your wallet, it will also increase the odds that a sound retirement nest egg will be waiting for you in the future. “I have never met anyone who told me that they wished they had saved less,” says Chris Chen, CFP®, wealth strategist, Insight Wealth Strategists LLC, Waltham, Mass. “People think that they will make up a withdrawal later, but it pretty much never happens.”

Read the full article here.

Is your 401(k) loaded with hidden fees?

Discover and assess the extra expenses hiding in your 401(k) plan.

When was the last time you looked closely at each line item on your 401(k) statement? There might actually be extra fees in there of which you are not aware. While it’s true that your employer likely pays for the administration expenses of the plan, you have to take a look at what other fees are being charged and determine which ones might be totally avoidable.

Below you will find some general rules and guidance when it comes to assessing those extra charges on your 401(k) statement.

By John Wasik

Generally, you should look for fees covering administration/recordkeeping, investment management and brokerage or advisory fees. Here’s what to look for, according to Grinkmeyer Leonard Financial:

Direct compensation: As its name implies, this type of compensation represents direct payments from the plan or plan sponsor to a provider for specific services rendered. It is typically paid as a flat dollar amount or as a percentage of plan assets. Fees that fall into this category often cover plan-level expenses, such as record keeping, administration, or advisory services.

Indirect compensation: Commonly known as revenue sharing, indirect compensation refers to fees generally collected from plan investments that are passed through to other service providers. Investment costs, including revenue sharing payments, often represent the majority of a plan’s total fees.

Other Fees. Ask about “Sub T/A” fees. which are paid to a subcontracted third party for the accounting of participant shares. There also may be “12(b)-1” fees, which are found in more than half of all 401(k) investment vehicles. This fee represents payment to broker for the sale a fund, and fees paid for the ongoing servicing of the account or plan.

There also may be a “shareholder servicing fee.” These fees are paid in addition to 12(b)1s for services rendered to the plan, such as recordkeeping and administration.

What do you do when you identified and tallied these expenses? Go to your plan’s administrator and ask how they can reduce the total cost to you. You can usually get a better deal, but you have to ask.

Read the full article here.

How Does Your 401(k) Balance Stack Up?

See how your retirement savings compares to others your age.

Do you ever find yourself wondering if that balance on your monthly 401(k) statement is enough? And how does it compare to the savings that others in your age group have been able to put away? It’s important to keep tabs on your retirement savings, and comparing your balance to that of others can actually help you to make moves in the right financial direction.

Below you’ll find statistics on the 401(k) savings of Americans in every age group, along with some tips on how to strengthen your retirement savings plan.

By Personal Capital

401(k)s are one of the most common investment vehicles that Americans use to save for retirement. The 401(k) is an employer-sponsored plan that allows you to save for retirement in a tax-sheltered way (up to $18,500 per year in 2018, with a $6,000 catch-up contribution limit) to help maximize your retirement dollars.

According to a Personal Capital-sponsored study conducted by ORC International, a majority of Americans (63%) with full-time or part-time employment participate in an employer-sponsored retirement program, yet just 21% max it out. It’s good to note that if your employer offers a 401(k) and you are not utilizing it, you are leaving money on the table – especially if your employer matches your contributions.

What Could You be Saving?

If you were maxing out your 401(k) (at the current contribution limit of $18,500/year), had an employer match, and started full-time employment at age 22, you could, in theory, have between $507,500 (with no growth) and $2,230,034 (with compounding and 8.8% growth*) saved for retirement by age 50**.

Needless to say, this is not a realistic scenario for many people. Life presents us all with different challenges – we don’t all start saving into our 401(k)s at 22, or we have unexpected medical expenses, decide to go back to school, or encounter other financial emergencies. These are all perfectly valid reasons for why you might be falling behind with your retirement savings.

The Average 401(k) Balance by Age

So, how much does the average American actually have saved towards retirement? And how do your own savings compare to the average American?

Take this free 401(k) assessment to see how you stack up.

This chart shows the actual estimated average 401(k) balance by age (middle column) and median 401(k) balance by age (right column):

*Source: https://pressroom.vanguard.com/nonindexed/How-America-Saves-2017.pdf

While these numbers seem low based on what people could have saved, our recent survey actually found that nearly two in five pre-retirees (37%) have no money saved for retirement. This is even more alarming when we consider that 54% of Americans believe they will need more than $1 million to retire comfortably, and half of pre-retirees (51%) want to retire at age 65 or younger.

But the good news is, while people are falling way below their savings potential, it’s not too late to turn things around.

5 Steps to Take Now When it Comes to Your Retirement:

Save early, often, and aggressively. Even if it’s uncomfortable to max out your 401(k), do it if you can. If you get a salary raise, immediately put 50% of it towards savings if you are able to. The earlier and more aggressively you save, the better off you will be. Compounding can do wonders when there is a positive annual return.

Don’t rely on Social Security. We found that a quarter of Americans expect Social Security to be their primary source of income during retirement. Yet according to The United States Social Security Administration, Social Security is on track to be depleted by 2034, paying only 79% of benefits (from ongoing tax revenue). With half of Americans (51%) planning to retire at 65 or younger, it’s crucial to save in other investment vehicles in order to maintain your desired lifestyle in retirement.

Have a realistic understanding of when you want to retire. Having clearly defined goals will help you determine how much you should have saved based on your personal situation. Your savings objectives will be different if you plan to retire at 50 than if you plan to continue working past 70. Additionally, it’s important to determine as accurately as you can what your cost of living will be in retirement.

Develop other sources of income. Think about other ways you can secure sources of income in retirement outside of collecting Social Security and withdrawing from your retirement accounts. This will not only prevent you from having all your retirement eggs in one basket, but it is also something to consider if your 401k balance is lower than you’d like. Where can you invest and how can you optimize your portfolio for greater returns?

Leverage all the resources at your disposal. There are many tools available to help you understand your financial life in more detail, and when these tools are so readily available, not leveraging them can result in a huge blind spot when it comes to your financial life. An online retirement calculator and planner can help you track your progress toward your retirement goals and scenario plan. If working with a financial advisor is an option for you, this can be an invaluable resource, especially as you get closer to retirement.

Understanding where you are spending, saving, and what your lifestyle costs are is crucial to your overall retirement planning objectives. If you feel overwhelmed by the prospect of saving for retirement, taking stock of the state of your finances is the first step that you can take towards getting a handle on your retirement planning. And you can do it starting today.

Read the full article here.