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ASK CARRIE You’re in Debt: Does a 401(k) Loan Make Sense? PDF Print E-mail
Written by CARRIE SCHWABPOMERANTZ Creators Syndicate   
Wednesday, 01 December 2010 22:40

Dear Carrie: I have $30,000 in revolving debt and unsecured loans with high interest rates. I have about $30,000 left in a 401(k); I borrowed $20,000 a few years ago for my kids' college tuition and closing costs on my home. I am46.

Should I borrow the money from my 401(k) to pay off the debt, or just leavemy 401(k) alone and let it continue to build? - A Reader

DearReader:You're in a tough spot. The simple answer to your question is no, you shouldn't borrow more from your 401(k). In fact, you may not even be able to, as I'll explain in more detail. But before we get into theses details, the most important thing I want to emphasize is that you need to curb your spending and stop running up debt.

I realize that youborrowed from your 401(k) for worthy goals, but the fact that you have $30,000 in "revolving debt and unsecured loans" sounds like you are living beyond yourmeans. If that's true, you need to tackle that immediately.


Most people really don't know where their money goes, so start by getting a clear picture of your spending patterns. It's usually easiest to divide things into necessary spending (mortgage payments, insurance, taxes) and discretionary spending (vacations, restaurants, entertainment, etc.).

You probably already know if you're spending more than you're making, but really knowingwhere themoney goes will help you find places you can economize. At this stage, the key is to create a budget you can live with.


The next step is to reduce your existing debt, particularly the high-interest, non-deductible debt. If you could pay off the $30,000 tomorrow, you'd see an immediate improvement in your budget (howmuch are you paying eachmonth in interest charges on the revolving debt and unsecured loans?). But that's an enormous challenge.

Your idea of using your 401(k) makes some sense - if you could actually borrow enough to eliminate your debt and you had the ability to repay the loan in the next five years (a requirement of most plans). If you don't pay, the 401(k) loan could be viewed as a distribution, which means you'll pay income tax and a 10 percent early withdrawal penalty - onerously expensive.

But 401(k) loans are generally limited to half the vested value of the account or$50,000,whichever is less. If you had no outstanding 401(k) loans and $50,000 in your account, you could probably borrow $25,000. But your ability to borrow is further reduced because (I'm assuming) at least some of your first loan is still outstanding. You'll need to check with your plan administrator, but at most you could probably borrow half your existing balance.

In other words, a 401(k) loan won't eliminate your revolving debt and the unsecured loans, and it will undermine your retirement plans. So, I think it makes more sense to leave your 401(k) alone and start paying down your credit cards and unsecured debt as quickly as possible, starting with the highest interest rate debt.


While debt reduction is critical, you should try to keep funding your 401(k) - at least up to the level of any company match, and more if you can afford it. At age 46, you've got quite a few years to build assets for retirement, but you don't have time to wait.

The easy availability of credit cards and home equity lines has created problems for many people, encouraging and enabling them to live beyond their means. Your challenge now is to relearn how to live on your income - and at least for awhile, to live on less than your income so you can repay the revolving debt. It may not be easy, but it can be done.

My general advice for other readers is to avoid borrowing fromyour retirement plan, except as a last resort andthenonlyif you are confident that you can repay the loan on time - and also continue to save. You can almost always find a way to finance things like college, but when it comes to retirement, you're generally on your own, except for Social Security.

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