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401k loans

Thanks for joining me. I’m going to be talking today about 401k loans and talking through the pros cons good situations when you should think about using them and when you should avoid them. And so the first thing I’ll do is I’ll cover the basics of just how the 401k loans work. I then I’ll dive into the, the pros and cons and let you know how to analyze those things for your specific situation to make sure it’s going to make sense for you.

[00:01:24] So you see the. Breaking the bank. That’s kind of what 401k loan is, is you’re kind of tapping into funds that are traditionally kind of wrapped up prettyr most part. But when you do access it for a 401k loan, technically you’re busting that open to use it for some other resource, other goal that you might have coming up.

[00:01:45] And so the reason why you would take out a 401k loan over any other option is there’s just not really that many ways to access your 401k, unless you’re age 59 and a half. Then there’s a special rule where you can do an in-service withdrawal. There’s also something called a [00:02:00] hardship withdrawal, but those are going to be very limited to, are you going to lose your house?

[00:02:04] Are you going to be evicted from your rental ? So those are very, very hard to actually use to tap into your 401k, but a 401k loan. There is no real guidelines that say, Hey, you can only take it out for these Set ofs. There are other rules that you need to be concerned with, but as far as the reason supporting your withdrawal and that loan, that there’s not actually anything critical that you need to overcome or some special strategy that you need to use.

[00:02:31] It’s just as simple as if your 401k offers it, then you kind of go and access it and the rules are going to be okay. Limited as far as how you’re able to access it. So typically you’re only able to access up to 50% of your 401k in that’s up to $50,000. So it’s, whatever’s the lower of 50% of your account balance or that $50,000.

[00:02:52] There is a special rule and it depends on whether or not your employer puts us in place, but there’s a different set of rules and [00:03:00] calculations where you can actually take up to a hundred percent up to $10,000. But after you go over that $10,000, then it’s back at that 50% calculation. So you want to be aware of that.

[00:03:10] Another neat thing and why a 401k alone can sometimes make a ton of sense is there’s actually. No tax situation that happens when you go and tap into the 401k loan. So if you take out a 401k loan, a lot of people are concerned about taxes, because normally if you take money out of your retirement accounts, there’s a taxes penalties, all these crazy things that you have to consider and factor in, but with the 401k loan, it’s protected within the 401k bubble still.

[00:03:38] And so the loan to yourself, not taxable as you pay it back, not taxable. So it’s really. Great benefit in future of a 401k loan, . And so another common question is like, how do you actually pay this back? So after you take out a 401k loan, It’s pretty simple. Most of the time your employer will just set this up.

[00:03:56] So it comes straight out of your paycheck, every single paycheck. And so [00:04:00] you gradually pay this down. Typically the longest you can take out a loan for is five years. There is an exception to that if you’re taken out to purchase a primary residence. So if you’re going to be purchasing a home. You can extend that out further.

[00:04:11] It could be 10 years. I I’ve heard them going up to 15, 20 years sometimes. And so just make sure that when you’re doing this, that it makes sense for you. As far as how many years you want to do that. A pretty common one that I’ll use with clients. If we do end up using this as a strategy is, is three years.

[00:04:27] We want to try to pay this back still pretty reasonably. And, and make sure that that’s all taken care of. And another big factor is how much is a 401k loan gonna cost. So most of the time, if you have a pretty big employer, that the cost is minimal, it’s like $15 every three months. So it’s very low cost to actually tap into a 401k loan.

[00:04:47] That’s why they’re so valuable as a strategy and as a asset and resource for you, should you need to, and. Most of the time. So you’ll definitely want to check the fine print and see how your phone [00:05:00] one K would be structured and what the cost would be. But for a lot of the larger companies that use like fidelity as their 401k provider, super minimal cost, practically nothing.

[00:05:09] When you kind of consider the grand scheme of things, Where the, the other big question mark comes in is, well, what about the whole interest situation? I’m taking out loans. So I know I’m paying interest somewhere. The crazy thing about a 401k loan, you’re actually paying the interest back to yourself. So it’s not like you’re paying into fidelity.

[00:05:25] You’re not paying it to a bank or anyone else. You’re paying yourself back that the normal amount that you need to on a monthly basis or out of your paycheck. And then you’re also paying interest back to yourself. So that’s dropping right back into your 401k. So, those are pretty phenomenal flexibility when it comes to a 401k loan where the cost really isn’t as bad or as extreme as you think it is because the interest doesn’t even count as a cost because you’re just paying that back to yourself.

[00:05:53] It’s kind of, if you force yourself to save an extra dollar a month because you, you took some money out or something like that. [00:06:00] So those are really the, the ground rules and kind of overview of how 401k loans would work. Right. When it comes to the pros, we’ve already kind of mentioned them just in the rule standpoint.

[00:06:13] So you’re not actually really paying interest since you’re just paying it back yourself. So that’s not a true cost or you’ret going to be text on it. So that’s another pro there. And those, those are going to be the most significant ones. Typically why you would use a 401k loan. One of the good reasons or examples, why it would make sense is if something came up there was an emergency or a big opportunity that you wanted to take advantage of, but you don’t have cash.

[00:06:38] You don’t have savings. You don’t have other resources that you could easily tap and a 401k loan could come into play there. I’ll help you. Throwing something on a credit card and paying 20% interest. Cause obviously if you’re paying 20% interest on a credit card that is going to the credit card company is where the interest on your 401k loan is just going back to yourself.

[00:06:57] So that’s, that’s really the [00:07:00] biggest benefit. I would say the cons where the cons could start to show up is when you do take out a 401k loan, you will be removing your money from being invested. So if it was invested and you go in and take a 401k loan out it’s no longer invested. So if the stock market goes bonkers and starts going up, all crazy, well, you’re going to lose out on that growth, potential growth opportunity.

[00:07:23] So even though it’s not a direct cost, it’s not a clear and easy to find costs. That is kind of like an opportunity cost. So if you take your money out of an investment, the investment goes up thats’s A costou’ll never actually recognize and see as a number but in the back of your head, or if I’m helping clients, I understand like, Hey, we took this out.

[00:07:42] That’s one of the things that you need to analyze for your situation. Does it make sense to do this and, and going from there? Cause that. Is the cost. It’s just not one. That’s very transparent and easy to understand for those types of situation. Another kind would be cashflow issue. So let’s say [00:08:00] your emergency or your situation is dire because of just a lack of monthly cashflow well a 401k loan will help with an initial injection of funds.

[00:08:09] But the problem is well you have to pay it back? And that’s, that’s one of the rules. If you don’t pay it back, then you do have to pay penalties and interest and taxes and all that crazy stuff. That that’s one thing that you want to be aware of that your monthly cashflow, you do need to pay this back.

[00:08:29] You need to be able to recognize that your paycheck’s going to be smaller because of the amount that you’re gonna be paying back to the 401k loan. So if things are already tight, well, maybe 401k loan doesn’t make the most sense if there’s other options and opportunities out there, but I’m still a big fan of always.

[00:08:45] Every resource available when you’re trying to strategize and choose the best thing for yourself. I think the biggest mistake that people make is when they use a 401k and the 401k alone. [00:09:00] A piggy bank for just kind of fun things, things that are not really urgent things that are not really big goals, but Hey, I want to buy a new iPhone.

[00:09:09] Well, I got money in my 401k. Let me just do a 401k loan and take the money out and use it for these miscellaneous things. Things that are not going to add a ton of value to you. Sure. It will be fun to have an upgraded phone or to go on a sweet vacation. But if you’re not saving enough for retirement and for your future in the first place, or you’re going to just have a lot of problems later on down the line.

[00:09:31] So that’s something you want to be aware of as you’re considering this 401k loans, it is taking away from your future self. So keep that in mind. But if it’s a situation where it just makes a lot of sense, because. Either you’re just in a tough situation and there’s no other way. There’s all the other ways would be too expensive or it could even just be something like a big opportunity coming up.

[00:09:55] Hey, if I had the funds, if things weren’t trapped in a 401k, I would [00:10:00] typically be able to get to this and be able to make this other investment or take advantage of this different opportunity. Well, then a 401k loan could make a ton of sense there, but doing it just to fund your lifestyle. That’s, that’s a definitely a guaranteed way to not be set financially in the future and you’ll constantly be having them.

[00:10:18] 401k for different purposes. If you just don’t have control over your normal day to day, month to month situation, a 401k loan is really for those unique opportunities and just also unfortunate times of emergencies, but hopefully your life isn’t in a constant state of emergency, and you’re able to allow your 401k to grow most of the time, allow yourself to build up emergency savings and.

[00:10:41] Tap into a 401k loan in case of emergency or these cool opportunities that tend to come up in life. So if you have any questions for me, I’d be happy to answer those. And if you were just jumping in now, you can always kind of search back through that, the previous comments and [00:11:00] Information on the pros and cons, but I’m actually a fan of using 401k loans.

[00:11:05] I’ve recommended it a handful of times to different clients. It doesn’t make sense for everyone, but again, it’s important to look at the whole picture, not just your savings, not just your. What you’re making on a monthly standpoint, but we’ve got to look at what goals are important to you. What’s coming up down the pike that we need to make sure we have funds for and saving for it, how much we’re able to save on a monthly basis.

[00:11:27] And, and what can you cover yourself just monthly? Maybe, maybe you do want to do something fun and cool. Coming up. It would be easy and you could definitely tap into a 401k loan to speed that up. Well, there’s still some logistics and a pain in a butt factor of putting in a 401k loan in place are then painted off.

[00:11:46] So I wouldn’t just recommend it for a thousand dollars or $2,000. They’d really have to be a sizable thing that you were having to undertake in order to do this. You don’t want to do it for $500 or a thousand dollars. It’s just not going to make a lot of logistical stuff. [00:12:00] But, and also if it’s just that small, you can just save up on a monthly basis.

[00:12:04] Say, Hey, if I save up $300 a month, well Three and a half months I’ll have the thousand dollars I need for this thing. So really it’s just forcing yourself to, to recognize, well, is it an immediate need and necessity, or is it something that I can plan and plan around this to still reach my goals and still do some of the things that you want to do without tapping in and, and opener your 401k loan, just to kind of fund some lifestyles things.

[00:12:31] So I appreciate everyone who hopped in today and you’ll be seeing this going live for. On my podcast, probably in about a month or so, I’ve started to record this my first live in like six months. So I’m excited to kind of get back into the flow of things, doing some live events, but then also curating these and breaking them down for other forms of content for you to, to search for.

[00:12:55] Yeah, let me know if there’s any questions on 401k loans or if there’s any other [00:13:00] topics that you have recommendations for in the future, because I’m going to be doing a lot more of these again, just like I was at the end of 2020.