In mid-December, I was minding my own business when I heard a news story that some 401K plans come with debit cards. The cards allow an employee to borrow against his retirement plan just like using a MasterCard - of course, eventually you must pay the 401K back for the "loan" you are taking, even if it's your money. [I do hate to point this out, but you have to pay back the MasterCard too.]
I was stunned that someone could easily finance a vente latte at Starbuck's by borrowing against his or her retirement account. What a potential for disaster.
In divorce cases, we often see parties whose only retirement [aside from Social Security some day] is in the form of a 401K plan. Often, that plan is the only source of funds the parties had when they wanted to make a down payment on a truck, condo in the mountains, or to pay excess credit card debt, and the balance has been reduced by the loan. They foolishly think their lives [and bad spending habits] will change and they will be able to repay the loan within a reasonable period of time. Unfortunately, that one latte may be added to the movie tickets, a tank of gas, dinner and a bottle of wine, repeated over and over again, until much of it is gone.
Compounding the problem is the forgotten provision in the plan that may require the loan be repaid, or be treated as a withdrawal. What happens with a withdrawal? Taxes, penalties, and loss of retirement resources.
Ask some questions. If your job is eliminated, does the plan require the loan to be repaid within a short period of time? Does the plan require any loan be repaid within a certain period even if you stay employed? If you leave the job and want to transfer your 401K to a new employer, you probably can't transfer the loan. If you get a divorce, for the same reason, the employee-spouse may be stuck with a loan that cannot be transferred to the spouse - will the loan then exceed the allowable loan percentage once the other spouse takes his or her share of the equity in the plan - that could trigger repayment provisions.
And remember, if you can't repay the loan when required to do so, that may trigger penalties plus income tax on the amount of the loan. If you are in a higher bracket, taxes and penalties may be more than one-half of the amount of the loan. And you thought you only had to worry about the stock market and Ponzi schemes!
In summary, don't do it except in an absolute emergency. Use your parking change and order a tall drip, add lots of cream, and forego the latte. Maybe check out a video from the library instead of going to a movie. Read a book. Go for a walk. Mend your ways. Sure, it doesn't stimulate the economy, but your household's economy must fix itself first.
