In real estate and in life, I have talked with clients and friends who truly believed borrowing from their 401(k) retirement savings plan was an option -- in fact, some even believed it was a necessity. All the same, after having counseled hundreds of people on money management and teaching these same families the importance of living on a budget, I have encountered three specific life scenarios where borrowing from a 401(k) seemed like a good idea at the time when, in fact, it was anything but.
Buying a Car
Never, ever, ever is it an even vaguely reasonable idea to take money out of your retirement savings account or pension plan to purchase a depreciating asset.
My advice: Buy the cheapest car you can afford, in cash -- no exceptions. For some of my clients, this means a $2,000 car, for others it means a $10,000 car. Regardless of what you can afford, you need to remember that a car is not a status symbol; it is a tool. All you need a car to do is get you safely from point 'A' to point 'B'; anything else is just superfluous.
Buying a House
When I worked in real estate, far too many of clients considered taking money out of their 401(k) for their down payment. And, like using money from your retirement fund to buy a car, this is just a terrible idea all around. The rate of return on a 401(k) is almost always better than the rate of return on a house, and now, you've thrown away savings earning a higher rate of return, in favor of a 30-year note, with interest.
My advice: Like a car, it's better to save up for your down payment in cash. FHA loans only require a minimum of 3.5 percent down, making these mortgages extremely affordable -- and easy to qualify for. For example, on a $120,000 house, the minimum down payment would be $4,200. If you cut out your frivolous spending and began saving at least $350 a month, you can have that down payment saved in 12 months -- or less. Obviously, you'd need to customize these figures for your budget, but taking money out of your 401(k) shouldn't ever be an option.
Buying a Business
For many of my clients, this has been a gray area. They believe that by investing money in a business, they will create a recurring source income, while fulfilling their dreams entrepreneurship. Even though all of that sounds great, you simply don't know if that business is going to fail or succeed. On top of that, you can almost always guarantee a financial loss in the first few years of any start up. Why throw away a sure thing on a gamble? That's just not smart money.
My advice: Use resources like Kickstarter.com to find venture capital. While you might be giving some of your business equity away in the beginning, if your business becomes a wild success, you can always buy out investors and go from there, without ever jeopardizing your retirement savings.
In life, there is a payment (or savings) plan for just about anything you can think of: buying a home, getting a car, starting a business, paying for college or doing home improvements, to name just a few. However, there is no payment plan for your retirement or for your future. If you find yourself tempted to borrow from your 401(k) for anything other than a major emergency, my advice expert advice is, don't.
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