Taking Money Out Of The 401K

Both McCain and Obama suggested allowing people to remove money from their 401K without penalty for the next couple years. The idea is to help people meet their short-term obligations. Sadly, this is the identical mindset that created the financial crisis to begin with. It is the product of short-term thinking. The long-term never enters the thought process.

Taking money out of one's 401K is the dumbest thing you can do. I know this since I did it a number of years ago. This cost me substantially over the last few years. Here is the scenario.

I had the opportunity to invest in a property. I hit up my 401K to finance part of the acquisition. This enabled me to get the property upon which I was going to build my real estate empire. Of course, an interesting occurrence called the collapse in the housing market altered those plans. I ended up losing the house.

Let's look at what I did to myself. The money in my 401K was put there tax free. It was pre-tax dollars. After I took it out, since it was a loan to myself, I repaid it with after-tax dollars. When I reach the age of 59 1/2 (or whenever I take it out), I will be taxed on it again. Thus, I pay tax twice on the same money.

Another thing occurred during that time period; the stock market shot up. The money that remained in my fund realized an average 24% annual return for a number of years. I missed this opportunity with the greater portion of my funds since they were removed. Therefore, my opporunity cost was substantial.

This example should show why the proposal of the candidates is stupid. However, there is one other point I want to make. People who take the money out of their 401K to meet short-term needs might alleviate the problem today. However, the odds are they will be in the same situation in the future. Also, when they finally do reach retirement age, I would guess the money will not be replaced. They will need a "bailout" at that time.

Remember this the next time you hear someone suggesting taking money from your retirement fund. It is a dumb move and I have the scars to prove it. Learn from my mistake.
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Sadvocate said...

It is naive to think that people will somehow stop contributing to their 401k's if they remove money from it now to pay off debt they can't get out from under. After all, the money got there in the first place. Many businesses match employee contributions - people will want to continue to receive the "free" extra money and will continue to contribute.

You contradict yourself in saying people won't learn from their past. After all, you did. Why wouldn't someone who is tapping into their retirement money not take the lesson to heart and stop living beyond their means.

The percentages of gain that many 401k's are seeing (or not seeing) is not going to gain money for people at the same rate that many high credit card interest rates are going to drain money from people. Getting people in a situation -now- where they are only earning interest in stead of paying interest is essential if people will ever be in a state to plan well enough ahead to be self sufficient in retirement.

It is time to wake up and realize that the systems in place are not going to take care us - including 401k's. What good will a 401K do if you get to retirement age saddled with $50,000 or more in debt?

Dennis Harting said...

Thank you for the comment. The point that you are missing is that most of the population will not change behavior. It is true that I learned from my mistake. Sadly, most do not.

The example that I use to back this up is the fact that so many refinanced their home to pay of high credit card debt. What happened? Many of the same people are now in credit card debt and have the higher loan on their card.

Taking money out of the 401K will not solve their issues. Money problems are never solved with more money. Money problems are solved with more education and changes in behavior. If they take the funds out of the 401, they will lower the balance that draws interest while these same people will run the cards back up over the next few years.

Habits are what dictate many of the results we get in life.

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