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Is Borrowing From Your 401(k) a Smart Move?

Is Borrowing From Your 401(k) a Smart Move?

Several years and two home states ago, I recall one of my co-workers telling me about how she was able to borrow from her 401(k) in order to buy a new car (or at least put a down payment on one). She went on and on about how low the interest rate was and, ultimately, how happy she was with her decision. This seemingly good advice stuck with me to the point that, some time later, I decided to give it shot in order to help fund my dream vacation to Tokyo.

While I didn’t know it at the time, it turns out that this move isn’t always as great as it sounds. In fact, borrowing from yourself can actually get to be quite expensive.

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The good aspects of taking out a 401(k) loan

On the surface, temporarily taking money out of your retirement account makes a lot of sense. After all, many of us won’t be retiring for a good long time, so what’s the harm in taking advantage of some of the funds now? Furthermore, if you pay the money back in a timely manner, there are no tax consequences to 401(k) loans, in sharp contrast to the penalties you will incur if you take out money directly.

Another reason these loans are so attractive is that they come at relatively low interest rates. For that reason, it may make more financial sense to borrow your own money as opposed to utilizing credit cards or personal loans that are transparently costlier. Because of these considerations, 401(k) loans can make financial sense and could even be the best option depending on your specific situation. However, there is more to be aware of.

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The rest of the 401(k) loan story

If you compare just the interest rate, borrowing from your 401(k) can seem like a steal. Unfortunately, what you could be stealing from is your future. What’s most borrowers do not account for is how the rate of return on your retirement account will be affected by the absent money. By removing a large chunk of your 401(k) funds, you’re hurting your growth potential. With some accounts earning between 5% and 8% annually, that could really add up — especially if you take a while to pay back your loan.

One more thing to keep in mind: if you fail to repay your loan on time, you’ll not only have to pay taxes on the amount you took out but will also have to pony up a 10% early withdrawal penalty. Similarly, if you leave the employer that hosts your 401(k), you will need to either pay the loan balance back immediately or suffer the withdrawal consequences. For those reasons, if you’re thinking about switching jobs, you may want to look elsewhere for your loan.

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So, is it a good idea?

Honestly, it depends. If your current job is secure and you only plan on borrowing a small amount for a short period of time, there may not be much harm in a 401(k) loan. However, cases in which you’re borrowing for longer or instances in which you’re mulling a change of career might not lend themselves well to this option.

Of course, another big factor is what you’ll be spending the money on. There are plenty of great ways to invest in yourself that might prove more important to you than the potential financial ramifications. To that point, there are definitely worse ways of gaining cash or capital than borrowing it from yourself.

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If you’re thinking about borrowing from your 401(k), the best thing you can do is research all of your options first. Just be sure to consider the long-term impact even a short-term loan could have and don’t jeopardize your retirement for things you need (or, worse yet, only “need”) today.

Featured photo credit: TaxCredits.net via flickr.com

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Last Updated on March 4, 2019

How to Use Credit Cards While Staying Out of Debt

How to Use Credit Cards While Staying Out of Debt

Many people will suggest that the best thing to do with your credit cards during these tough economic times is to cut them up with a pair of scissors. Indeed, if you are already in huge debt, you probably should stop using them and begin a payback strategy immediately. However, if you are not currently in trouble with your credit cards, there are wise ways to use them.

I happen to really love my credit cards so I will share with you my approach to how I use mine without getting into deep financial trouble.

Ever since about 1983 when I got my first Visa card, I continue to charge as many of my purchases as possible on credit. Everything from gas, groceries and monthly payments for services like my cable and home security monitoring are charged on credit. Despite my heavy usage, I have maintained the joy of never paying any interest fees at all on any of my credit cards.

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Here are some tips on how best to use your credit cards without falling into the trap of paying those nasty double-digit interest fees.

Do Not Treat Credit Cards as Your Funding Sources

Too many people treat their credit cards as funding sources for major purchases. Do not do this if you want to stay out of trouble. I use my credit cards as convenient financial instruments so I do not have to carry around much cash. In fact, I hate carrying cash, especially coins. When you buy things on credit, the purchases are clean and you will not get annoying coins back as change.

I do not rely on my Visa, MasterCard or American Express to fund any of my purchases, large or small. This brings me to my golden rule when it comes to whether I will pull out any of my credit cards either at a retail or online store.

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I never purchase anything with my credit cards if I do not have the actual cash on hand in my bank account.

If I really cannot pay for the item or service with cash that I already have at the bank, then I simply will not make the purchase. Remember, my credit cards are not used as funding sources. They are just convenient alternatives to actual cash in my pocket.

Make Sure to Always Pay Off Balances in Full Each Month

The next very important part of my overall strategy is to make absolutely sure that I pay the balances in full each and every month no matter how large they are. This should never be a problem if the cash has been budgeted for my purchases and secured in the bank. I have always paid my full balances each month ever since my very first credit card and this is why I never pay interest charges.

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Using Credit Cards with Rewards

Most of my credit cards are of the “no annual fees” type, including one MasterCard on a separate account I keep at home as a spare in case I lose my wallet or incur any fraudulent charges. However, I do use a main Visa card which does have an annual fee because all purchases on that card reward me with airline frequent flyer points. For me, the annual fee is worth it since I do travel and I get enough points to redeem many free flights.

You have to decide for yourself if you will charge enough purchases on credit each year without paying interest charges to warrant a credit card that rewards you with airline points (or other rewards). In my case, the answer is “yes” but that might not be the case for you.

I occasionally use a MasterCard or American Express card on small purchases just to keep those accounts active. Also, I have been to the odd retailer that accepted only a certain type of credit card, so I find that having one from each major company is quite handy. Aside from my main Visa card which earns the airline points, the rest of my cards are of the “no annual fees” variety.

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So this is how I use my credit cards without getting into any financial trouble with them. This strategy is recommended only if you are not in debt, of course. In fact, it is worth keeping in mind once you’re out of debt so that you can keep your credit cards active and treat them responsibly.

What are your credit card usage strategies? Let me know in the comments — I’d love to hear what methods you use.

Featured photo credit: Artem Bali via unsplash.com

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