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Fix My Finances: I borrowed from my 401(k)

Welcome to Fix My Finances, Yahoo Finance’s personal finance series. In each episode, we take a look at one viewer’s financial state of affairs and offer advice, insight and information on a variety of issues, including how to save more, spend less and pay off lingering debt.

In this episode we spoke with Corey, a 33-year-old from Atlanta, Georgia. Corey ran into some money troubles in his twenties and got deep into debt. He filed for bankruptcy in 2008. Corey has since gotten married and has been trying to build back his credit, but his debt and spending habits are getting in the way, particularly his love of travel.

Corey’s first priority should be to pay back the money he borrowed from his 401(k).

Deep in Debt

Federal student loans make up the majority of Corey’s debt, a total of $150,000 for him and his wife combined. Corey also has $3,500 in credit card debt with an interest rate of 20%. His wife has a $20,000 car loan with a 4.5% interest rate, and the couple recently took out a $4,000 personal loan.

But to make matters worse, Corey also borrowed from his 401(k) retirement savings account—taking a $5,000 loan out for personal expenses.

“Borrowing from [his] retirement account was a huge mistake,” says New York–based financial planner Stephanie Genkin. “It’s time to start taking responsibility.”

Borrowing from your future

Like Corey, most people who have a 401(k) can borrow from it, in most cases, up to either 50% of the vested balance or $50,000, whichever is less. But that doesn’t make it a good move, especially for someone in Corey’s situation.

Borrowing from a 401(k) is taking money out of the market and putting it in your pocket. With every major U.S. stock index hitting record highs last week, that’s savings lost.

Corey will actually be taxed twice by borrowing from his retirement account. Genkin points out that when he repays the loan to his 401(k), he will be doing so with after-tax money. Then when he reaches retirement, Corey will pay taxes on that same money when he makes withdrawals.

Taking responsibility

Corey is on the hook to pay back the full sum of the loan. He’s already paid back $1,500, but Genkin says paying off that remaining $3,500 needs to be a priority.

Most borrowers have five years to repay a 401(k) loan. But it’s important to note that if he leaves his job, Corey will be required to pay back the full sum within 60 days or face tax consequences. The sooner he pays it back, the better.

New focus

Corey may be pretty deep in debt, but he and his wife are both employed and make a good income. In addition to his 401(k), they have a joint savings account and a small brokerage account too. Genkin suggests using that money to pay back the loan.

“With a combined household income of $100,000,” Genkin says,  “[Corey and his] wife should be able to make some headway on debt repayment and improving [their] credit score.”

But discipline is key and curbing expenses is just as important as chipping away at debt. Corey needs to “make paying back debt—not [his] lifestyle—the focus,” Genkin says.

Want to be a part of this new series? We are looking for people in their 20s and 30s who need a money makeover.  Apply here.