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Today’s post is from Ashley at Budgets Made Easy. She paid off $45,000 in debt in 17 months and now helps people do the same.
Have you thought about taking out a 401(k) loan?
It can seem like a great option.
The interest rate is low and it can be appealing to “pay yourself back”.
However, there are risks that are associated with taking out this type of loan.
Of course, all of the reasons to not take out a 401(k) loan happen to us.
Here is my story about how my 401(k) loan ended up costing us almost $1,000,000 in future earnings.
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How a 401(k) Loan Cost us Tons of Money
Taking out a 401(k) is very appealing in terms of finding financing. Especially if you don’t have many other options.
A little back story about our situation.
My husband and I bought our dream home in November 2012. We found out I was pregnant 2 months later.
There was a major issue with our dream home. The main house was a small two bedroom that would not have fit 2 cribs. There was a seperate in-law suite that was not connected to the main house.
We could solve the problem by enclosing a covered porch that would connect the main house to the in-law suite which would also add another bedroom and playroom.
The problem with this plan was that we couldn’t get another mortgage without moving into the balloon mortgage area.
So, my husband talked to some of his co-workers and they told him that a 401(k) was a great loan.
We decided that it seemed like the best option.
We took out the loan and then a few days later, I checked the 401(k) account and realized they actually withdrew month from the account.
I wrongly had assumed the money was a normal loan with the 401(k) as collateral. I did not realize they took money out so it’s not earning compound interest.
We completed the construction a month before our second daughter was born and all was well. I returned to work in December and continued on with our lives.
Where the problems started
The first week of January 2014, it all came to a crashing halt.
I returned home from work as a detective to find my husband already home, which was odd.
He looked at me and I could tell something was wrong. He said “I lost my job”.
After the panic wore off, I reviewed our budget and savings and figured out how long we could survive and pay the mortgage.
I realized we would be okay for a few months, especially since I had returned to work.
All was well while he was looking for a job. Then we got a letter in the mail saying that we had 60 days to pay back our 401(k) loan of around $20,000.
Well without a job, I wasn’t going to be able to get another loan and I wasn’t going to use our savings. So we ignored it and moved on with our lives.
My husband got an even better job and we were back to our normal lives.
Then came the IRS
The next year at tax time, we got a letter stating that since we didn’t pay back the loan, it would count as income on our taxes.
I then started to panic since the money was gone and we didn’t really earn an extra $20,000.
It bumped us into the next tax bracket which hurt us even more.
We went from getting several thousand dollars back to owing $6500 to the IRS. So the loan cost us about $10,000 just in taxes and penalties.
The silver lining
Once we found out how much we owed in taxes, I was stressed and anxious about how to pay for it. I had some money in savings but I didn’t want to use that, you know in case my husband lost his job again.
So we ended up putting it on a credit card with zero-percent interest for 18 months.
Then the next month, I started getting the credit card bills and realized I didn’t have a clue how we would pay it off in 18 months.
I started searching for debt pay off plans and found Dave Ramsey. I got to work on our budget, cutting costs, selling everything, and working a ton.
We were able to pay off $45,000 in 17 months! We not only paid off the credit card before the 18 months were up but ALL our consumer debt!
All because of a zero-based budget and determination.
All the issues with the 401(k) loan put us on the the path to being debt-free and using that knowledge to help others.
After our friends saw our progress and they started asking how to do it too. That turned into starting my blog so I can help other families pay off their debt as well.
If it weren’t for the issues with this loan, we would still be a normal family and debt and I would still be working a job I didn’t want any longer. Since paying off our debt, I am now able to stay at home with our three kids, which is where I want to be.
The long-term costs
So even though there is a rainbow after the rain, that 401(k) loan still had some major long-term costs that I just recently realized.
We were young and in our twenties when we took out that loan.
Based on the industries standards for estimating long-term compound growth on investments, we lost around $1,000,000 dollars by taking out that loan.
This is just in lost earnings that money could have made us for retirement had we left it alone.
Issues with 401(k) loans
Are you considering taking out a loan from your 401(k)?
It may seem like the best option, like it did for us but it probably isn’t.
If you lose or want to change employers you have either 60 or 90 days to pay back what is left on the loan.
Even if you think you have a secure job, you don’t. My husband worked at his job for 7 years and was liked by everyone but one person.
That one person screwed him out of a job.
There is even the possibility that you find your dream job or want to move out of state. You are stuck until that loan is paid or you can pay it in full.
It severely limits your opportunities.
If you do lose your job or change jobs and can’t pay it back, you will be subjected to interest and penalties. It’s the same as if you took a withdrawal out of your 401(k).
People told us it wouldn’t matter because “if you lose your job, your income will be less that year anyway”. Well that wasn’t true for us. Especially with this loan.
Then if you do owe taxes, how are you going to pay that? We paid practically a 50% tax on the loan.
You are losing compound interest. Every single day that your money is not in your retirement account, you are losing money for retirement. It doesn’t matter if you pay it all pay in 5 years. It’s lost interest over those 5 years.
If you are still considering taking out a 401(k) loan, I implore you to sit down and run the numbers. It could end up costing you thousands and thousands of dollars over time.
I often get asked if I regret taking out the loan or if I would still do it again, knowing what I know now.
The answer is I would not do it again. I don’t regret it looking back on it now, I regretted it from the first day that I looked in our account and saw the money was taken out.
I was mad about it for years afterwards after all the issues kept adding up.
However, it brought me to where I am now. I would not be debt-free, running a business, or staying at home with my kids had I not gone through all that.
So, no regrets now but I certainly wouldn’t do it ever again.
I would wait and find the money by other means.
I would encourage you to do the same. Decide if what you need the money for is really a need or a want. Determine other ways that you could get the money. What can you sell? Can you work extra or find extra work? Can you cut costs in your budget?
There are likely other ways, even if it takes a little longer or more work. It will be worth it!
Ashley Patrick is a Ramsey Solutions Master Financial Coach and owner of Budgets Made Easy. She helps families eliminate debt using simple strategies so they can stress less and live the life they want.
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