Many American’s Taking A Loan From 401k

Taking A Loan From 401k PlansA recent article by the Washington Post highlighted a very scary personal finance situation that many Americans are facing: they are taking a loan from 401k plans. The article cited that over 25% of retirement plan holders are taking a loan from 401k plans to pay for current expenses. There are a handful of issues here, each of which I want to address separately.

Taking A Loan From 401k Plans

  • With the financial state this country is in, taking a loan from 401k plans is a horrible idea. With looming cuts to Social Security, workers are going to find it nearly impossible to retire because they do not have enough income to survive, even if they follow these 3 tips to retiring well. That is of course if you want to have any sort of comfortable retirement. The article gives the example of Charlotte Knox:

            Charlotte Knox, 62, has worked as a housekeeper at Baltimore’s Hyatt Regency hotel since 1984. She earns $13 an hour, is struggling to recover from a hip replacement and is planning to retire next month. But partly because of past withdrawals, her 401k balance is only $60,000, which is all she has to supplement her Social Security. “I don’t have any money,” she said. “I’m just taking it a day at a time. That’s all I can do.”

Sadly, there are many other Charlotte Knox’s out there that don’t understand that it will be virtually impossible to survive on her $60,000 and Social Security. She is destined to live in poverty and on food stamps the rest of her life.

  • The idea behind a 401k plan is to let the money grow over your working career. It may not seem like it, but that 5% you sock away each paycheck does add up over time. It’s called compound interest. Given time, your balance does grow.
  • But in order for it to grow, you have to keep saving for retirement. If you cannot afford to put 10% into your 401k plan, then you need to look at your spending habits. Most likely, you are spending more than you earn, which is one of, if not the biggest cardinal sin that keeps you from being financially well-off. If you need to take a loan from your 401k plan, then chances are you are living beyond your means. There are some situations where you may have to take out a loan, but this is the exception and not the norm. If you need the cash to pay your credit card bill or to cover this month’s mortgage payment, you are most likely living beyond your means. Some may argue that you or your spouse lost your job and now you are having trouble paying your bills. To that I ask if you have cut out every other want in your life? Did you cancel the cable bill? Have you cut back on eating out or buying new items? Are you eating Ramen noodles for dinner? These are things that have to happen when times get tough. They aren’t fun and it isn’t easy. But it is something that has to be done.
  • The article points out that those in their 40’s are the most likely culprits of taking a loan from 401k plans. This makes sense when you think about it. People in their 40’s most likely are married, have upgraded their home, have a few children, and have nice cars. They have a standard of living they are used to. If something happens and one of them loses a job, it is hard to lower your standard of living. It’s easier for a person in their 20’s to do so, simply because they have been living on less for a few years. But as we age and get accustomed to our lifestyle, it is hard to reduce it.
  • According to the article, the typical household nearing retirement has $120,000 in retirement savings. That amount of money is going to last at most five years. I say this because most people underestimate how much they actually spend. If you have this amount of money and retire at 65, what are you going to do when you turn 70 and have no money?

Mandatory Emergency Funds

One person interviewed in the article stated that the number of people that takes out a loan shows that workers would rather have the cash than be forced to save for retirement. Part of me agrees with this and the other part doesn’t. The part that does says that maybe employers should first set up a trust-like account with an employee. For the first five years, the company will match 3% of the employee’s pay into this fund. It will be an emergency fund and when the balance reaches a target amount or five years, then the company match goes towards the employee’s retirement plan. The trust-like account cannot be accessed for those five years.

The part of me that is against this says that giving employees cash instead of a match for retirement doesn’t address the real problems: first, people live beyond their means and second, they don’t save enough for retirement. Living beyond one’s means is not the employer’s job, so they should not be forced to make sure an employee is living within their means. Also, if you do not match or otherwise encourage employees to invest in their 401k plan, they lose their greatest asset, time. The longer they wait to start saving, the more they need to save.

Final Thoughts

What’s the answer? I have no idea. People have to want to be financially stable. Many say they do, but then they go stand in line for the new iPhone because they HAVE to have it. Until people truly want to become financially stable, I don’t think there is any hope. Maybe the answer is to scare people into saving for retirement. I remember back in high school going to a mandatory presentation on drunk driving and smoking and drugs. They would show images of the aftermath of drunk driving accidents and people that smoked and had cancer would speak along with ex-drug addicts. The idea was to scare us into not doing any of those things. Maybe we need a mandatory meeting on people living in poverty and how hard their life is and how their lifespan is shorter than others to scare people into living within their means and saving for retirement.

Readers, what are your thoughts on so many people taking a loan from 401k plans? Is there anything that can be done to make people understand doing so is a bad idea?

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  1. says

    While this is a scary stat, it really does not surprise me one bit. It points back to a number of factors, in my opinion, but all goes back people not having a long range view of things. There are so many other things one should consider before taking a loan before I would consider it a viable option. I would also like to know what number of people leave the loans and don’t try to pay them back.
    John S @ Frugal Rules recently posted..Losing Isaac – Finding Life in the Death of a ChildMy Profile

  2. says

    I read the article and it’s not entirely clear to me why people are taking out 401K loans. If you lost your job, have an underwater mortgage and kids to feed… well you do what you got to do. It’s hard to fault these people for trying to survive. If you are feeling compelled to pay for luxury kitchen renovation, spinning rims, and iCrap…. What the hell is wrong with you?

    Personally, I don’t rely on my 401k or Social security for retirement. I’m working on funding my own very early retirement via aggressively building passive income streams. Too many people don’t realize that the best use of money is making more money, not buying stuff.
    My Financial Independence Journey recently posted..Lockheed Martin Corp (LMT) Dividend Stock AnalysisMy Profile

    • moneysma says

      Great point. The article really doesn’t explain what people are using the money for. I’m with you – working on developing various income streams to retire early.

  3. Christian L. says

    You can’t touch your retirement savings. Period. I don’t understand the purpose of putting money into a retirement account of any kind if you can’t leave it there. Examine your budget and figure out where to put money that you need to access and where to put money you need to save for retirement.

    -Christian L. @ Smart Military Money

    • moneysma says

      Exactly. Retirement money is for…retirement. If you have a house down payment account do you raid it for a new iphone? I hope not since that money is for a house.

  4. Les says

    I certainly understand folks having to dip into their savings plans to pay for necessities during this terrible economy (which I doubt will get any better soon). You have to do what you have to do. But, I think it is a good idea to borrow from your retirement accounts to buy income producing assets such as rental property and then repay the accounts with the income, or just continue to reinvest in more assets. DO NOT do this if you cannot discipline yourself enough to follow the plan! A self directed IRA is a great way to force yourself to be disciplined.

  5. says

    I believe I read the same article and found it to be sad. Raiding your 401k or any retirement account is just a recipe for failure. It’s not intended to be your emergency fund, so I don’t know why people treat it like that. I too do not agree with handing people the cash. To some degree I like that you have to be forced into saving in order to get the matching. Sometimes people need the extra motivation in order to do the right thing.
    MMD @ IRA vs 401k Central recently posted..401k Income Limits – Can I Make Too Much to Contribute?My Profile

  6. jim says

    While I agree, generally, with the sentiments expressed here, I must make a confession. I took a $15,000 loan against my 401(k) to build a deck on the back of our house. It’s a 5 year loan and it pays my 401(k) back at 4%. That, essentially, amounted to a mere $125 out of my check. We never missed that $ and we’ve had a whole helluva lot of fun on that deck ever since – grandkids/family/neighbors/friends over for cookouts, swimming parties and just hanging there ourselves talking, reading etc. It actually has been one of the best “investments” we’ve ever made and I don’t regret it for one nano-second.

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