Sunday , 3 December 2023

The PROS and CONS of Borrowing Against Your 401(k) – (+4K Views)

Look, if you’re absolutely stuck right now, then you’ve got to do what’s necessary but, in my opinion, you should avoid 401(k) hardship withdrawals at all costs … and think long and hard before you consider borrowing against your future retirement. With so many people nearing retirement already grossly underfunded [such actions are] going to prove catastrophic down the line. Words: 1043

Lorimer Wilson, editor of, provides below further reformatted and edited [..] excerpts from Nilus Mattive’s ( original article* for the sake of clarity and brevity to ensure a fast and easy read. (Please note that this paragraph must be included in any article reposting to avoid copyright infringement.)

Mattive goes on to say:

Fidelity reports that a record number of Americans are making hardship withdrawals from their 401(k) retirement plans (and, worse yet, those borrowing from their plans is also at a 10-year high!). [In addition to mortgaging their future retirement well-being such] withdrawals get assessed an additional 10 percent penalty besides the regular taxes [they must pay on the withdrawal amount as income in the year of withdrawal meaning that a large portion] of their nest egg money gets vaporized before it even goes toward their immediate needs!

PROS and CONS of Borrowing Against Your 401(k)
Fidelity said 45% of the people who took a hardship loan last year took ANOTHER ONE this year. On the surface it’s better to take a loan than an outright withdrawal because taxes and penalties aren’t assessed [the one and only PRO) but here are a couple of CONS:

#1. Unlike hardship withdrawals, there are no hard-and-fast rules on loans so there is no guarantee that this money is truly being borrowed for dire circumstances. People could simply be tapping their future retirements in the same way that they tapped their home equity a few years ago.

#2. While it is true that this money should ultimately be repaid, and at least the interest will go back to into the retirement account, it essentially means that very little new money will be contributed. The end result will be a lower final balance and the loss of the very tax advantages that make 401(k)s attractive in the first place.

How to Remove Money from a 401(k) Plan
The 401(k) plan is the most ubiquitous retirement account in the United States, and for good reason: Any money employees contribute is not counted for income tax purposes. Instead, it’s taxed — along with investment earnings — upon withdrawal. So how and when can money come out of a 401(k) plan?

1. Upon Retirement
Retirement is defined by the tax code as the contributor reaching age 59 ½. At that point and beyond, any money that comes out of a 401(k) plan is simply taxed as regular income.

2. Through Separation of Employment
In this case, the contributor has four choices, which boil down to:
a) Leaving the money where it is
b) Rolling it over into a new employer’s plan
c) Rolling it into an Individual Retirement Account
d) Withdrawing it.
When done correctly, the first three options don’t result in any taxes or penalties. However, the fourth option DOES (unless the employee also happens to meet the conditions for retirement discussed above).

In short, money that comes out of a 401(k) plan before the contributor reaches age 59 ½ results in both regular income taxes being due but ALSO a 10 percent early withdrawal penalty.

3. Hardship Withdrawal
While they’re not required to do so, most 401(k) plans allow contributors to remove money under certain circumstances — including medical expenses, the purchase of a principal residence, tuition and related educational costs, and funeral expenses. Individual plans have some leeway in how they specifically define “hardship” and what particular events can trigger withdrawals.

The IRS does provide the following guidelines:
a) “For a distribution from a 401(k) plan to be on account of hardship, it must be made on account of an immediate and heavy financial need of the employee and the amount must be necessary to satisfy the financial need. The need of the employee includes the need of the employee’s spouse or dependent.
b) “Under the provisions of the Pension Protection Act of 2006, the need of the employee also may include the need of the employee’s non-spouse, non-dependent beneficiary.
c) “A distribution is not considered necessary to satisfy an immediate and heavy financial need of an employee if the employee has other resources available to meet the need, including assets of the employee’s spouse and minor children. Whether other resources are available is determined based on facts and circumstances.”

The IRS will:
a) not impose the 10 percent early penalty on these withdrawals in a few specific cases such as death, permanent disability, or termination of service after age 55 – but in most other cases it will
b) require payment of ordinary income taxes on the amount removed and
c) bar the individual from contributing any new money to any employer retirement plan for at least the following six months!

4. A Loan
Most, but not all, plans will also allow participants to take out loans from their 401(k) accounts. Generally, these loans have five-year terms — unless it’s for a primary residence — and carry fixed interest rates. Repayments must be made in regular installments, and everything goes back into the 401(k).

Think long and hard before you consider borrowing against your future retirement [because, with] the other typical sources of retirement income looking shakier than they ever have before, tapping your 401(k)s may find you completely out of options in your golden years.

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  1. 401k choices are often limited to a small handful of mutual funds – this forces a saver into becoming a speculator by participating in a volitile market. Also, the government may at any time sieze your retirement assets by taxation or inflation. No thanks – Angel

  2. You’re kidding, Munknee, right? The worlds financial markets are dying a slow, gasping death and you counsel people to keep their money in 401k?

    Anyone with half a brain can see that they better take their money while they can and plunk it on a nice piece of land somewhere where they will be able to at least exist when the crash comes.

    Land is 56 cents a square yard. That’s cheaper than carpet and a better investment than any financial instrument.

    For Judy, paper precious metal investments will disappear like any other paper security. A wise person would be holding their own physical metals.

    • Chris,

      No, I have a small gold and silver IRA where I have physical metals, but since it is an IRA I am not allowed to hold it myself so it is held by a company called GoldStar. Or is this still considered what people refer to as paper precious metals? I guess I thought paper precious metals were like gold ETF’s, stocks, etc.

      Yes, I am a bit confused as well (as you can tell from my earlier post), what the reasoning is to hold on to our IRA’s for now, if they are going to be confiscated in the future? Your suggestion seems more prudent to me as well, but I am wondering what/if I am missing something financially since I’m no expert. Thank you.

      • As long as you have paper in your hands and not your metals you are in a vulnerable position. There are a couple IRA’s where you can hold your own metals but the smart money would be to cash the IRA out, take the tax hit, and start buying metals on your own.

        About 5 years ago we put our money in metals that we physically hold. Our investment has gone up about 300%. No paper will ever beat that.

  3. Great article but I am really hoping you will expound on this further. On Sept. 3, 2010, you wrote an article about the government getting ever closer to (in effect) taking our retirement accounts. And then the next day, Sept 4, 2010, you give advice to not take loans, etc. from our retirement accounts. It would seem to me, that if you have a precious metals IRA especially, maybe now IS a good time to close them out. If we were to close out now and pay the tax (which is at a lower rate than it seems it will be in the future) and pay the 10% fee, that this would/could still be made up for as the price of gold goes up in the future, rather than risking the government taking them over completely. Anyone’s thoughts and insight on this would be greatly appreciated. Thank you.

    • Judy,

      What you described is exactly what I have done. After the 08 crash, I rolled all my 401k (was laid off), IRA and other retirement accounts into a physical gold IRA. Then in 2009 decided to start closing my account by taking physical possession of the metal. A little in 09, little more in 10 and I just closed out the remainder last week. Before the end of the year in 10, gold price more than covered my taxes and penalty. They are coming for the retirement accounts, they will have no choice. I figure by the time I get ready to start withdrawing my funds in retirement, taxes will be much higher also, so I just avoided higher taxes. I also stayed with small 1oz silver coins, much easier to barter with.