In this episode of the Great Retirement Debate, Ed and Jeffrey explain whether or not you should borrow from your 401k if you need liquidity.
[00:00:00] INTRO: Hi, I’m Ed Slott, and I’m Jeff Levine, and we are two guys who just love to talk about retirement and taxes. Look, our mission is simple to educate you, the savers, so that you can make better decisions because better decisions on the whole lead to better outcomes. And here’s how we’re going to do that. Each week, Jeff and I will debate the pros and the cons of a particular retirement strategy or topic with the. Helping you keep more of your hard-earned money. Yeah, but we won’t know which side of the debate we’re taking until we flip a coin winner of the coin flip gets to pick which side of the debate they want to argue, and both of us will have to argue in favor of our respect positions, whether we agree with them or not. At the end of each debate, there’s going to be one clear winner you, a more informed saver who can hopefully apply the merits of each side of the debate to your own personal situation to decide what’s. For you and your family.
[00:00:52] INTRO: So here we go. Welcome to the Great Retirement Debate![00:01:00]
[00:01:02] Jeffrey Levine: Hey, welcome back to the Great Retirement Debate, Ed. Good to be back with you for our latest episode.
[00:01:08] Ed Slott: That’s right. Great retirement debate. The winner. Is everybody listening.
[00:01:13] Jeffrey Levine: Well, what are we debating today, Ed?
[00:01:16] Ed Slott: Uh, whether somebody should borrow from their 401k or not, especially in these economic times. People see a big account there and they say, you know, I need money. Maybe I should tap into that.
[00:01:27] Jeffrey Levine: Well, maybe they should, maybe they shouldn’t. We’ll find out. So your topic, I get to pick the coin. Flip, uh, I’m gonna go tails today. Ed, I gotta say tails. And let’s flip that coin.
[00:01:37] Ed Slott: Alright, uh, here we go. Real coin.
[00:01:42] Ed Slott: Heads.
[00:01:42] Jeffrey Levine: Heads. All right, well you get to, you get to make the choice, Ed.
[00:01:47] Ed Slott: Uh, I’d like, or I’m gonna go with the easy one. At least in my, I’m, I’m going say, don’t borrow from a 401k.
[00:01:54] Jeffrey Levine: All right. That means I am arguing for taking a loan from your four [00:02:00] Ed, you could lead us off. Why shouldn’t you? You seem pretty passionate about this.
[00:02:03] Jeffrey Levine: Why wouldn’t you take money from your 401k?
[00:02:05] Ed Slott: Well first again, we say, you know, if you are listening to this, there are two sides. Like we flip, flip the coin of every argument and people might be thinking about this. I never liked the idea borrowing from a retirement account, uh, only because. Unless it’s your absolute last resort, I mean, it takes years to build a good retirement savings plan, a little at a time, a week at a time, month at a time, and then you just take it out. It’s the hardest money to replace, and if you use it before retirement, what’s going to be left in retirement. So those are the main things I worry about. Now, I’ll turn it over to you.
[00:02:42] Ed Slott: Why for the other side of the.
[00:02:45] Jeffrey Levine: Well, I mean, I, I would say at the starters, if you’re looking to take a loan from your 401k, you probably need the money. And so it’s not so much a matter of, do I take it? It’s where do I get it from? And the question is, where else could you get it? Are you [00:03:00] gonna borrow from family? Well, that we know can be very messy. And one of the great things about a 401k loan is that, you’re getting money tax free, right? In a lot of places, if you were going to get, if you were gonna need dollars, right, you could take a distribution from your 401k or distribution from your ira. But if you’re under 59 and a half, not only would you have income tax, but you could have a 10% penalty on top of that.
[00:03:24] Jeffrey Levine: Whereas if you take a loan from your 401k, you’re actually able to access that money without paying an income tax. Just like any other loan you would take.
[00:03:34] Ed Slott: You know, I’ve heard that argument, but in real life I’ve had clients that did that in the past and it didn’t work out well. Uh, it’s true. They were in the same situation you are talking about.
[00:03:44] Ed Slott: Uh, they had no other money. Now, this was a bad case because they, it was a second marriage for both of them, and they wanted to use the money for their wedding. I mean, you know, second marriage, I don’t call that essential. You know, I gave him the advice [00:04:00] and they didn’t listen to me. So they took money.
[00:04:02] Ed Slott: The husband, it was the one that had the 401k, took money out of his, he borrowed from his 401k cause he had a balance there. And then he, he couldn’t pay it back. Uh, and then all of a sudden it becomes a taxable distribution. And the very penalty you’re talking about being worried about, uh, he got hit with.
[00:04:19] Ed Slott: Plus when they had to pay the tax, they didn’t have money cuz they spent all the money on the wedding. Uh, so there was almost no intention. Maybe there was an intention, but there wasn’t an ability to pay it back. That’s why I said, you know, if you’re gonna use it for food or shelter, something like that.
[00:04:35] Ed Slott: But, uh, and I’m not saying the, the big wedding, and it wasn’t even a big wedding, but they wanted to do something and there was no other money available. I advised against it. But the, uh, if you can’t pay it back, it’s a real problem. And I find a lot of people, although there are schedules and some people may be able to pay it back, I find most people, at least in my experience that did this, were not able to pay it back and had to suffer the [00:05:00] consequences.
[00:05:00] Jeffrey Levine: Well, let’s talk about that schedule for a moment, because a lot of times when people borrow money for emergencies, they’re typically short-term loans, right? They might borrow some money from a family member’s like, wait, I’ll hit you back next month. Or I’ll catch up with you over the next year. Well, that’s a short period of time.
[00:05:16] Jeffrey Levine: And while not 30 years, like let’s say a mortgage, with the exception of some, uh, some loans that are used to purchase a home, there’s a five year timeframe in which you can pay back those 401k loans. So even though it’s not. You know, 10, 20, or even 30 years, like many mortgages might be, uh, you are looking at a period of time that’s dramatically longer than a lot of short-term loans would be.
[00:05:39] Jeffrey Levine: Plus, uh, when you go to take out a loan, let’s say you were looking at someplace else to get the money and you had a, a house already. Maybe you needed to make repairs or maybe you just need to pay for. You know, again, whatever it is, if you were to go for a loan from your house, you’re probably paying loan origination fees.
[00:05:56] Jeffrey Levine: You’re probably paying, you know, some sort of fees to the bank. [00:06:00] Whereas if you take that money from your 401k, you are able to access that money without all those upfront costs that you would from other loan providers.
[00:06:09] Ed Slott: Yeah, I get that it’s, uh, easier to obtain credit, but, uh, another problem with this, is it easier to take – even if you can pay it back? Okay. Let’s say somebody’s diligent and they’ll be
[00:06:20] Jeffrey Levine: OK, someone’s diligent.
[00:06:22] Ed Slott: Yeah. and, and it, you know, there’s always good intentions, but you know what they say, the road, whatever. Is paved with good intentions. The intention is always to pay it back because if you don’t pay it back, uh, your retirement account will forever be lower and won’t provide you what you’ll actually need in retirement.
[00:06:41] Ed Slott: But, if you do, even if you do pay it back, I find the people that have paid it back, something else has suffered. They only have so much money. Remember, these are people that had financial issues, uh, emergencies, whatever it was, because otherwise they wouldn’t be tapping a 401k. Hopefully they would [00:07:00] look for other areas of credit if available, but now they have a limited amount to pay back.
[00:07:06] Ed Slott: So they pay back because they wanna stay on the schedule, which means they probably don’t have the disposable cash to continue making 401K contributions. So in that respect, you’re replenishing, but you’re not replenishing the contributions going forward.
[00:07:22] Jeffrey Levine: Ed, let me ask you a question. If I take out a loan from the bank, are they gonna give me that loan for free?
[00:07:29] Jeffrey Levine: I mean, besides origination cost, is there any other cost associated with that loan?
[00:07:34] Ed Slott: There’s lots of costs associated with a bank loan, and sometimes you might not even be credit worthy.
[00:07:39] Jeffrey Levine: Okay. But let’s just say I am. Okay. Is the bank gonna give it to me for free? Or am I gonna have to pay some sort of interest to, to have the privilege of borrowing?
[00:07:47] Ed Slott: No, of course you’re gonna pay interest.
[00:07:49] Jeffrey Levine: Okay. If I borrow money from someplace else, am I gonna have to pay interest?
[00:07:52] Ed Slott: Is a trick question. Yeah. Loans have interest. There’s no free, give me the name of that bank that hey, gives out the free money.
[00:07:58] Jeffrey Levine: Well, that’s my point, because [00:08:00] if I’m taking a 401k loan, I am paying interest. But Ed, who do I pay that interest to?
[00:08:07] Ed Slott: All right. Here’s the argument you pay.
[00:08:08] Jeffrey Levine: I pay it to me! Yes, that’s right.
[00:08:10] Ed Slott: Back to your own 401k and that’s an argument, but I can argue the other way. You all, you’ll pay tax twice on that money. You have to pay tax, uh, on the money you made to, uh, get the money in. Well, you get a deduction for it.
[00:08:25] Ed Slott: But when you want to make, uh, you’ll need new money to, uh, make new contributions.
[00:08:31] Jeffrey Levine: Effectively you’re saying to pay back the loan, I’ve gotta use after tax money that that goes into a 401k, that later on in retirement, when I take a real distribution, I’ve gotta pay tax on it again.
[00:08:40] Ed Slott: Right, right. So you pay tax. I don’t, not twice on the same money, but you pay tax twice. That’s the way I look at it. When people say, uh, give the same argument, that’s probably number one argument. I’ve seen it in articles. Oh, pay yourself back interest now, instead of going to the bank, it goes to you. It goes to your 401k. The interest and it has-
[00:08:57] Jeffrey Levine: That’s right.
[00:08:58] Ed Slott: Cause those are the rules. [00:09:00] But you’re still out that money and, uh, where are you gonna get the money to pay it back and to make future contributions? I don’t like it as a planning tool that that’s all unless it’s an absolute last resort?
[00:09:14] Jeffrey Levine: Well, let’s, let’s go down that road. Let’s just say I’m, I’m sitting there and I’m looking at my IRA or my 401k and where I’m gonna tap that money from and I have to get money from somewhere.
[00:09:23] Jeffrey Levine: I think the 401k is a much better option because there I can actually borrow that money, but what happens if I borrow money from my IRA, Ed?
[00:09:31] Ed Slott: Uh, you can’t borrow from your IRA, that’s a prohibited transaction. And uh, just cause you went down that road, I’ll have to open that road up. Uh, you mentioned borrowing from your IRA.
[00:09:41] Ed Slott: People think you can, you really can’t, but there are articles about a so-called 60 day loan where you could take money from an IRA and roll it back within 60 days.
[00:09:51] Jeffrey Levine: It’s just a fancy name for a 60 day reollover.
[00:09:53] Ed Slott: Right. But with IRAs, you can only do that once a year, every 12 months. If you, once [00:10:00] you do a second one, you can’t roll that back over, so that becomes a taxable distributions, it seems to me, with any kind of, so you can’t borrow from your IRA.
[00:10:09] Ed Slott: Yes. If you had to borrow 401k, at least it’s available. It’s not available from an IRA, but in any case, down the road. If you’re looking long term. And I can understand if people say, well, I can’t look long term. I need money now, I feel like that commercial, uh, I need cash now…
[00:10:27] Jeffrey Levine: Yes, yes, yes. Uh, JG Wentworth, I believe.
[00:10:29] Ed Slott: Yeah right. Yeah.
[00:10:29] Ed Slott: Other than the JG Wentworth thing where I need cash now, uh, you know, that would be the case. But, uh, if there’s nothing else available, it’s, it should be a last resort. You’re, you’re hitting the, the account you’re counting on in retirement. That’s why they call it a retirement account. And you should do everything you possibly can to keep, not only, uh, keep that intact and not borrow from it, but keep contributing to it as much as possible.
[00:10:56] Jeffrey Levine: Well, all good points, but I would once again say that [00:11:00] if I’m forced to take money from somewhere, it may be better to go into my 401k, then certainly better than my IRA may be better than having to go into my home to get money where I am going to pay origination fees, and I’m gonna be paying someone else interest, and I’m still gonna have to pay that back too, and it may be better than going to a family member where if I don’t pay that back, you know, if I don’t pay my 401K back, my penalty is financial. If I don’t pay a family member back, my penalty is, well..
[00:11:31] Ed Slott: Forever.
[00:11:32] Jeffrey Levine: Yes. It’s, it is forever. Yeah. , uh, and, and, and so that may be worse, uh, ultimately, but look, I, I, I think one thing we, we certainly both agree on here is that retirement accounts as, uh, as a general rule of thumb, should be considered for retirement could be used for retirement. Um, and, you know, I’ll, I’ll throw one other item out here, Ed, that is really, uh, in favor of the 401k loan. In lieu of that, someone might be tempted to [00:12:00] put a, uh, a large purchase on a credit card or some other form of revolving line of credit and the interest rates there, it’s amazing how they don’t border on usery sometimes, you know, with 18, 19, 20% rates. So even if you are in a situation where you. You know, you’re not even sure that you’re gonna be able to pay back the 401k loan. It’s not great. Not advocating for, not saying, Hey, let’s try not to pay back that loan. But if my choice is take a 401k loan out and potentially default on it, or put money onto a credit card where I’m gonna have, you know, a 20% annual fee or annual interest plus penalties each month. If I can’t make my minimum payments or whatnot, I might just wanna bite the bullet, you know, suck it up for the time being, see my retirement account reduced, and then go about trying to improve my life, improve my financial situation, and build back that 401k later, because even though that 401K maybe less now, I might have a better ability to [00:13:00] build it up in the future if I’m not paying those astronomically high interest rates that credit cards and other revolving lines of credit often charge.
[00:13:07] Ed Slott: That’s true, but also I said it before, uh, if you default, you will not. You will have to pay, you’ll have a taxable event. So let’s say you withdrew, you’ll borrowed a few thousand dollars, that becomes a taxable distribution, that can’t be rolled over, by the way, with other money to an IRA, plus a 10% penalty if no other, uh, if you’re under 59 and a half.
[00:13:33] Ed Slott: So it can be very costly. That’s 10 per, you’re talking about interest rates. It’s a 10% penalty if you’re under 59 and a half plus the tax.
[00:13:42] Jeffrey Levine: Yeah. Well, at least it’s only a 10% one time penalty. And if I have to pay it, you know what I could do, Ed?. I could just borrow more from my 401k.
[00:13:50] Ed Slott: Aye, aye aye.. Well, you know, you can make the decision for yourself. Everybody listening, that’s why we’re here for, but, uh, I’m not a big fan and I think, uh, [00:14:00] Jeff just said it before, one thing we agree on retirement accounts should be for retirement, but life happens.
[00:14:04] Jeffrey Levine: That’s right. That’s right. That’s fair. Yes, life happens. Um, well, Ed, I think we’ve covered both sides of this pretty well, and so we can wrap it up here.
[00:14:12] Jeffrey Levine: And as we always say, there are two sides to every coin, but your life and your retirement decisions are too important to leave up to a coin flip. And that’s why one thing that Ed and I always agree on, is making sure that you’re talking through any big decision like this, like whether you should take a loan from your 401k or from someplace else with a knowledgeable financial advisor or tax professional, so that you can weigh the pros and the cons of different options against your specific goals and objectives.
[00:14:39] Jeffrey Levine: If you’d like to continue the discussion with Ed and I, we’d love to hear from you. You can reach Ed on Twitter using the handle @TheSlottReport. Again, that’s the Slott Report with two Ts and you can reach out to me using the handle @CPAPlanner. Once again, that’s @CPAPlanner. We’d love to hear from you. We’d love some of your thoughts on a future [00:15:00] topic for discussion for us to debate, and we thank you for listening. Ed?
[00:15:05] Ed Slott: Yep. I will see you next time on the Great Retirement Debate!
[00:15:08] Outro: Jeffrey Levine is Chief Planning Officer for Buckingham Wealth Partners. This podcast is for informational and educational purposes only, and should not be construed as specific investment accounting, legal or tax advice.
[00:15:18] Outro: Certain information mentioned may be based on third party information, which may become outdated or otherwise superseded without notice. Third party information is deemed to be reliable, but it’s accuracy and completeness cannot be guaranteed. The topic discussed in corresponding arguments are those of the speakers and may not accurately reflect those of Buckingham Wealth partners.