401K LOANS |TRUE COST EXPLAINED
401k loans are tricky. They seem like a great idea. You’re borrowing from yourself instead of someone else. But the true cost is tough to see. So in this video I’m going to explain the true cost of 401k loans by sharing the story of our $42,000 mistake.
So if you’re considering taking a 401k loan out of your retirement account, you NEED to watch this to see a real life example of the true cost of a 401k loan.
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LEARN MORE ABOUT: 401k Plans
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Saving for retirement is essential for financial security in our golden years. Many people rely on their 401(k) plans to build a nest egg for their retirement. While traditional wisdom suggests that withdrawing money from your 401(k) early is a bad idea, there is an option to take out a loan against your 401(k) if you are facing a financial emergency. However, it is important to understand the true cost of 401(k) loans before making this decision.
A 401(k) loan allows you to borrow money from your retirement savings and pay it back with interest. The maximum amount you can borrow is usually 50% of your vested account balance, up to a maximum of $50,000. The interest rate on 401(k) loans is typically prime rate plus 1-2%, which is lower than what you would pay on a traditional loan. The repayment terms are usually five years, but can be longer if the loan is used to purchase a primary residence.
One of the advantages of a 401(k) loan is that the interest you pay goes back into your retirement account, so you are essentially paying yourself back. This can be a better option than taking out a traditional loan and paying interest to a bank. Additionally, there is no credit check required for a 401(k) loan, making it more accessible to those with poor credit.
However, there are several disadvantages to consider. If you leave your job for any reason, the outstanding balance of your 401(k) loan must be repaid within a short time frame, usually 60-90 days. If you are unable to repay the loan, the outstanding balance will be considered a distribution and subject to income tax and a 10% early withdrawal penalty if you are under the age of 59 ½.
Taking out a 401(k) loan can also impact the growth of your retirement savings. When you borrow money from your account, that money is no longer invested in the market and may miss out on potential gains. Additionally, the interest you pay on the loan is not tax-deductible, unlike a traditional mortgage or student loan.
In conclusion, while a 401(k) loan can be a useful tool in times of financial need, it is important to understand the true cost and consequences before taking one out. It is advisable to explore other options such as a home equity loan or personal loan before tapping into your retirement savings. Consult with a financial advisor to determine the best course of action for your situation and ensure that you are making an informed decision about your financial future.
Did you factor in the double tax that you will need to pay on the interest portion of the loan?
Dave Ramsey talks about these mistakes over and over again.
Thank you. I’m 43 and have $60,000 in my 401k and was about to get a loan for $29,000 for 5 years. I have a question. In 5 years I’m getting $125,000. What would you suggest I do with it? Should I put it all in my 401k and let it all compound? Or is that not the correct thing to do with this additional money?
Excellent spreadsheet organization. You don’t find that often. I normally prefer my dollar amounts right justified, but……..one sec…….I’m being told this isn’t the main point of the video. 🙁 🙂 carry on……
"What of instead of paying off debit I just put it all into savings."
is there anyway to catch up
Similarly I feel embarrassed for not contributing to my 401k for 6 years because I didn’t like my new employer’s plan. It’s bad bc I worked in the retirement plan industry for 6 years smh.
Point, get to it
Question – so are these calculations assuming that you’ll always have a 7 % interest? And what is the percent you pay in fees per year for the management of the 401k- since that fee is a percent of the total value in your 401k. And what if Wall Street fails like it has in the past?
I withdrew a lot and paid my loan on 401k that’s because I am earning more this year. I have been investing while working at the same time. I invested through TERESA JENSEN WHITE, same woman that an anchor ‘jim cramer’ kept mentioning on CNBC, and made multiple of my start up capital within three months . She lives here in the USA and she is licensed
Great comparison analysis.
Sorry for your loss.
Thank you for sharing your story to help others.
I’ve seen banks point out the difference is between the interest rate of the loan and compounded growth (loan at 5% and growth at 8% thus only -3%). In actuality it’s the -5% and +8% so 13%. If calculated. I think.
So glad you put this information out. I read many people that put out their Budget Confession say they have taken out a 401k loan but they are ok with it because "I'm paying myself back with interest". They just don't get it. I enjoy your channel!
Does anyone think they will have a 401 k left after this administration? The great reset ? Lol
Honestly taking out the loan wasnt the issue…. the issue is when you keep running up credit cards and spending money that you dont have.. you lose more money that way… money that you aren't paying back to yourself
Thanks for sharing, great content! I have a story on 401k. In 2018 I borrowed $8k from my 401k for a primary residence I bought for $153k and today that property is valued at $300k. In 2019 I took out a second personal loan of $21k out of my 401k for an investment property that was $154k today that property is valued at $300k. 2020 I took $50k out of my 401k with the Cares Act Withdrawal. So I said that to say, it depends on what you’re talking it out for. Thank you.
thank you so much for this. i was thinking of doing the same but you changed my mind…. thank you thank you
you should have included the 16% int rate on your cc debt in scenario #2 to be apples to apples in analyzing opportunity cost, since you would not have paid it. but, underlying all this, you made a good point about having better spending habits so you would never be faced with 16% in the first place.
Well you are much better off than I am. I took two loans amounting together about $1600 in the year of 2000. It is now 2021 and I am defaulted on my loan. I went through a series of hardships including homelessness. I now have been trying to rebuild but I am still in default in excess about $40000 just in compound interest. I have tried to research on what I can do to possibly removing the interest that has accumulated. If I should apply for retirement then possibly I may have to pay about $ 8000 in taxes just for me to get about $400 monthly. Now if I wait til full retirement then there will be nothing left. So you see, I know it's saddening but your situation is much better than mine.I just wish I could change the hands of time and do things differently .