Borrowing Against a 401(k) Is Dumb
Frank has 16 people on staff with a 401(k) in place. Recently, an employee asked if she could borrow against her 401(k) in order to buy another car. What should Frank's response be?
QUESTION: Frank in Los Angeles has 16 people on staff with a 401(k) in place. Recently, an employee asked if she could borrow against her 401(k) in order to buy another car. What should Frank’s response be?
ANSWER: You have the option of making that option available as an employer. I don’t make it available because I think it’s stupid. I don’t want to do things that harm my team. I want to do things that help my team.
Borrowing against a 401(k) is a dumb idea for any reason. On a personal financial basis, in terms of answering the question for your employee, the reason it’s a dumb idea is when you leave the company—and you will leave the company when you die, when you get a better job, or when you get fired, one of the three, you will leave the company—when you leave the company, the loan is called due in full, and if you don’t pay it within 60 days, the IRS considers it an early withdrawal, and they will hit you with penalties and taxes. Dumb idea.
The second reason it’s a dumb idea is the stock market has been performing beautifully lately, and to unplug your 401(k) investments and good growth stock mutual funds and only pay yourself back an interest of 5% or 6% when you could’ve been making 12, 14, 15 or 20% is a dumb idea, so it’s a really bad idea.
What I would do if I were in your shoes—again, not inside our company but I’m just saying if I were outside of our company in a traditional company, not a company that sells financial counseling, which obviously we do—but if I were in your shoes, I would offer to put the employee through Financial Peace University so they can learn how to get on a budget and save and pay cash for their car. I’m not trying to sell you that, but my point is that the problem is not the 401(k) and the problem is not borrowing money. The problem is that the overall financial health of the team member is not good. Otherwise, they wouldn’t want to borrow money to buy a car.
Whether it’s our product or one of the other products, that would answer the question and get them financially healthy and then you don’t just sound like an ogre for saying, “No, we don’t borrow on our 401(k) because it’s stupid,” even though that is actually technically the correct answer.