My wife stopped working and started staying home when we
had our little ones. Now we have a lot of credit card
debt weíd like to get rid of. Assuming I have a solid
401(k) balance for my age, is it wise to take a loan
from my 401(k) to pay off the credit cards? Iím 40 and
have $165,000 in my 401(k).
You have saved a good amount for retirement, but without
knowing your income, itís not clear if itís enough.
planners tend to want people to have at least enough
savings when they retire to provide annual income thatís
70 to 80 percent of their pay in the last year they were
working. When you are close to retiring, you can quickly
look at whether youíve saved enough by multiplying
your salary by 12. If your savings match that, you are
in the ballpark.
age 40, you can test to see if you are on your way. By
that age, you need to have built up 2.4 times your
existing annual pay to get to the 80 percent threshold
eventually. So if you are making $100,000, that would be
a sum of $240,000 in the 401(k).
your pay is $50,000 a year now, you would need to have
accumulated $120,000. If you think you can get by on 70
percent of your last year of pay in retirement, then at
40 youíd need two times your current pay ó or
$100,000 if your income is $50,000.
even if you are close to being on target with your
saving, I am reluctant to suggest borrowing from your
401(k) to pay off credit card debt.
are likely to save yourself some substantial interest
charges if you do wipe out your card debt with a 401(k)
loan. Paying about 4.5 percent interest to repay a
401(k) loan makes a lot more sense than paying 12
percent on credit cards. And when you pay interest on
the 401(k) loan, the money goes back into your savings,
not to a bank.
often when people wipe out their credit card debt with
an alternative loan, they donít take the steps to
build a more carefree future by setting up a budget,
looking for cuts in expenses or finding an extra job.
Before they know it, they are stuck with a lot of debt
by TIAA-CREF of people who have borrowed from 401(k)
plans shows that 43 percent borrow a second time. So,
clearly, the first loan didnít give them the fresh
start they imagined.
when they borrow from their 401(k), they undermine their
future ability to build the retirement money easily.
The larger the sum of your early savings, the more
interest or return you make for the future, even if you
add modest amounts as you near retirement. So a nice sum
in your 401(k) at 40 means you are making your future
less stressful. Consider the impact of time on tiny
early life savings: A person who puts $25 a week into a
401(k) starting at 21, invests it in a balanced mutual
fund of stocks and bonds, and leaves it there, is likely
to have close to $1 million by retirement. A person who
would like the same nest egg, but waits until age 45 to
start saving, would have to save about $300 a week.
consider a 401(k) loan impact: Letís say you decide to
you try the "Should I borrow from my 401(k)"
you will see that you will end up at retirement with
about $20,000 less than you would if you hadnít
touched the money. I assumed that your 401(k) stock and
bond mutual funds earn about 8 percent a year, on
average, and that youíd repay your 401(k) loan over
the typical five years at an interest rate of 4.5
you end up failing to repay the $20,000 you borrowed,
you will have $399,000 less at retirement than if youíd
left your money in the 401(k).
you probably have every intention of repaying your loan
as required over five years. But if you fail to repay
it, the federal government will make you pay taxes and a
10 percent penalty on the money you withdraw from the
if it was $20,000, your federal taxes could be $5,600 if
you are in the 28 percent tax bracket. Also, there would
be state taxes and a federal penalty of $2,000. So your
$20,000 loan is a lousy deal. You end up giving Uncle
Sam more than $7,600 of it.
86 percent of people who lose their jobs end up failing
to pay back their 401(k) loan and suffer the penalties,
according to research by the Pension Research Council at
the University of Pennsylvania. The government generates
more than $1 billion this way.
you lose your job, you typically are given 60 to 90 days
to pay off the loan.