Harmful Money Decisions (Borrowing from Retirement)
Harmful Money Decisions (Borrowing from Retirement)
One of the drastic measures that people sometimes make, which tends to be a poor decision, is dipping into their retirement fund to pay off debt. This decision can become very harmful to any type of retirement plan that was previously in place.
No matter if it is a 401(k), IRA, Savings, or Mutual Fund type retirement, dipping into these funds before they mature can cost more than what you borrowed.
As an example, you lost your job and it has been over 4 weeks since you worked. The bills are starting to pile in. It is easy to start to panic if you have never experienced this type of situation. Trying to figure out what to do you fall back on your IRA retirement fund. You have saved up almost $7000 over the last 5 years.
You try and rationalize using the money and think to yourself, "I am young, I can make this money up once I find a new job." So you convinced yourself to cash out the fund.
You use the $7,000 to payoff all the immediate bills, plus the ones that were not due, just to get them out of the way. Now, for the consequence of what has been done.
First of all, that $7,000, if invested in an account that earned a modest 7% for the next thirty years, would have a value of almost $57,000 after 30 years. This is if nothing was ever put into the account but the $7,000. This is eight times the value of the investment. Even if you do make up the amount down the road, you still lost valuable interest and time.
The next thing is that there can be taxes, penalties, and interest due to the Internal Revenue Service (IRS) for early withdraws on retirement fund type accounts. This can cost up to half of what was withdrawn.
Retirement funds are meant to be left alone to grow over time and possibly be used for a "real" emergency. Otherwise, the funds are long-term accounts that should not be disturbed.
One of the more common types of borrowing is borrowing from a 401(k) plan. This is because eighty three percent of workers who have a 401(k) account, borrow against them. Another reason is because financial service companies
encourage employers to make loans available. They feel that employees are more apt to contribute to the 401(k) funds if they know that their money is safe, yet they can still get at it if needed.
One bad thing is that the people who do borrow against their retirement fund while they are working, can still fall victim. If they get laid off or possibly fired, they are required to pay back the full amount of the loan with in a matter of weeks.
If unable to pay back the full amount, the IRS considers this action as a withdrawal to the account. Now you owe taxes and fees for dipping into the retirement fund before the age of 59.5.
Once you turn 59.5, you become eligible to make withdraws on the retirement account without incurring any penalties or fees. This is how most retirement funds are designed, to be used later in life.
Some other alternatives so as not to get tied up into using the retirement funds, is to assess the situation in a calm and collected manner no matter how tense it may seem.
Write out a budget of all the bills in one row and all the incoming cash flow in another. Try and figure out if you can consolidate some debt to low interest credit cards that you may have. Contact all your creditors and inform them of your situation and see if they can setup a lower payment plan for that period of time or see if they can defer all of the payment for a month or two.
One car payment deferred for a month can help relieve hundreds of dollars. This will also help protect your credit by taking an active role in working with creditors. Do not wait until you miss a payment or a day before it is due.
If this is a temporary set back, most creditors understand and will work with you to protect you and themselves. There may be fees or incurred interest that needs to be paid, so be sure to ask questions before committing to any suggestions they might offer.
Try not to use any type of retirement fund or savings since this in itself has consequences that can be more costly than paying for some extra interest on a loan or a small late fee.
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