Earlier, I wrote a few posts on financial failures on our route to financial independence and early retirement (FIRE). The idea was to share that everything hasn’t been challenge-free on our route to a life of goofing off.
Today’s story isn’t patently a financial failure, but it runs completely counter to the advice that you might typical hear as you build your retirement nest egg. I can imagine seeing a headline on a personal finance site that says “5 REASONS NOT TO TOUCH YOUR 401K”. That said, we did touch our 401K – via a loan in our 20s – and it worked out very well for us.
The reason that you are not supposed to do this is that even if your employer allows loans, you might not keep up your payments back to the 401K or might lose your job before the loan is paid up. In both situations, the loan would trigger either an immediate payback (which you probably wouldn’t have the $$ for), or be considered a 401K withdrawal which incurs a sizable penalty (10%) and immediate tax-event (30-50%). This would mean that much of the amount you have been saving up for retirement would be forfeited to the government before it can grow.
We were aware of these risks when we took a $10K loan from my MegaCorp 401K when we were in our 20s. We had a bit of credit card & student loan debt leftover from college and had our sights set on buying our first house. To accelerate our ability to make a house down payment, we took a loan from my 401K with 6.5% interest terms. It was a large portion of our 401K balance at the time and had we not been able to keep up with it, it probably would have wiped out a few years 401K savings.
The great thing about it though was that we used half of it to wipe out our debts – which had a lot higher interest rate than 6.5% – and were able to shift the investment into a house that we could enjoy everyday. We probably would have waited a year or two more to be able to achieve those two goals. Even though it was ‘debt’ – it was a debt to ourselves and I felt better about it at the time.
While I would be hesitant to encourage my own son to do the same trick when he is in his 20s, it did work out very well for us. The repayment was simple since MegaCorp pulled the money directly from my paycheck (which was going up each year). I think the term of the 401K loan was supposed to last 5 years, but we paid it off a year or two early out of an annual bonus. While I felt like I dodged a bullet when it was completely paid off, I did end up working for that MegaCorp for 24 years in total, so I had plenty of time to pay it off. Few people work that long for a company now a days.
What has been your experience with your 401K – have you stayed hands-off?
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