There’s a hidden time bomb ticking in your 401(k) that could leave you with $300,000 less to spend in retirement than you would otherwise have, according to a new study from Deloitte Consulting LLP.
This hidden leak in your 401(k) could cost you $300,000
When people borrow money from their 401(k)s at work, they often do so with the best of intentions.
They really mean to get around to “paying themselves back” — a rationale that is more fallacy than truth, as we’ll show you in a moment — but sometimes life gets in the way.
There are a couple problems here right off the bat…
In the first place, the fact that you need a 401(k) loan may signal you’re in a financial death spiral, as hard as that can be to admit.
If this is the case, borrowing money as a quick fix — instead of getting on a tight budget as a way to implement a long-term fix — is nothing more than rearranging the deck chairs on the Titanic as it goes down.
Another potential problem with taking out a 401(k) loan is what happens if you suddenly and unexpectedly lose your job.
If that happens, you typically have 60 days to repay the loan in full — otherwise the money is treated as income and taxed accordingly.
And then there are the other ever-present dangers when you have a 401(k) loan, namely defaults and cashouts.
Check out this hypothetical example
Say you’re a 42-year-old with a 401(k) balance of around $77,000. Now, let’s say something happens in life and you need to borrow $7,000.
Sure, it’s less than a tenth of your balance — but it can have an outsize impact on your future, as we’ll see in a moment.
Now consider this: We’ve already established that you may be teetering on the precipice of financial chaos if you need to take a 401(k) loan. So what happens if Murphy’s Law prevails and everything goes wrong in your financial life, culminating in you defaulting on that $7,000 loan?
Well, Deloitte has a grim picture of the future in the scenario they’ve run.
Let’s say that initial default is followed up by you saying the heck with it and just cashing out the entire remaining $70,000 of your 401(k) to deal with taxes, early withdrawal penalties and to help clean up whatever financial mess you’re in.
This is more common than you’d think. Deloitte says that about two-third of folks who default will just go ahead and liquidate their account entirely.
That’s expected to account for $48 billion of lost wealth that’s being self-plundered from retirement accounts in 2018 alone, according to Deloitte.
But, wait, there’s more!
What started as a $7,000 loan that you defaulted on quickly ballooned to a $77,000 cashout in our example. But here’s where it gets really bad.
Deloitte crunched the numbers and found it all adds up to a scenario where you’re likely to have $300,000 less in retirement.
That’s because you miss out on $217,000 of potential investment return when your money isn’t there to grow for you!
4 more reasons why you shouldn’t borrow from your 401(k)
Need more reasons not to borrow from your 401(k) to begin with? Here you go!
1. You’re likely to reduce or stop your contributions during payback.
About half of people who take out a 401(k) loan are believed to reduce current 401(k) contributions during their repayment window. That’s because they’re struggling to make those payments back. And worse still, it’s believed a third of people end up stopping contributions completely during their repayment time.
2. The ‘Hey, I’m paying myself back’ rationale isn’t so straightforward.
When people do a 401(k) loan, they tend to justify it by saying, “Well, it’s my money. I’m paying myself back.’ But the thing is, you pay yourself back with after-tax money that then will be taxed again when you retire!
3. If you do it once, you may do it again.
Once you take out your first 401(k) loan, what are the odds you’ll do another? You have a 50/50 chance of this being a case of wash, rinse and repeat, according to some reports.
4. The real cost is opportunity.
Taking the long view, the stock market has a lot more up years than down years. So if you’re not as invested in the market because you’ve reduced or stopped your contributions during payback, you’re missing a lot of the gain that takes place over time. That’s the idea behind “opportunity cost.”