A recent article by the Washington Post highlighted a very scary personal finance situation that many Americans are facing: taking a loan from their 401k plan. The article cited that over 25% of retirement plan holders are taking loans out again their 401k plan to pay for current expenses. There are a handful of issues here, each of which I want to address separately.
- With the financial state this country is in, taking a loan from your 401k plan is a horrible idea. With looming cuts to Social Security, workers are going to find it nearly impossible to retire because they do not have enough income to survive. That is of course if you want to have any sort of comfortable retirement. The article gives the example of Charlotte Knox:
Charlotte Knox, 62, has worked as a housekeeper at Baltimore’s Hyatt Regency hotel since 1984. She earns $13 an hour, is struggling to recover from a hip replacement and is planning to retire next month. But partly because of past withdrawals, her 401(k) balance is only $60,000, which is all she has to supplement her Social Security. “I don’t have any money,” she said. “I’m just taking it a day at a time. That’s all I can do.”
Sadly, there are many other Charlotte Knox’s out there that don’t understand that it will be virtually impossible to survive on her $60,000 and Social Security. She is destined to live in poverty and on food stamps the rest of her life.
- The idea behind a 401k plan is to let the money grow over your working career. It may not seem like it, but that 5% you sock away each paycheck does add up over time. It’s called compound interest. Given time, your balance does grow.
- But in order for it to grow, you have to keep saving for retirement. If you cannot afford to put 10% into your 401k plan, then you need to look at your spending habits. Most likely, you are spending more than you earn, which is one of, if not the biggest cardinal sin that keeps you from being financially well-off. If you need to take a loan out from your 401k plan, then chances are you are living beyond your means. There are some situations where you may have to take out a loan, but this is the exception and not the norm. If you need the cash to pay your credit card bill or to cover this month’s mortgage payment, you are most likely living beyond your means. Some may argue that you or your spouse lost your job and now you are having trouble paying your bills. To that I ask if you have cut out every other want in your life? Did you cancel the cable bill? Have you cut back on eating out or buying new items? Are you eating Ramen noodles for dinner? These are things that have to happen when times get tough. They aren’t fun and it isn’t easy. But it is something that has to be done.
- The article points out that those in their 40’s are the most likely culprits of taking out a loan. This makes sense when you think about it. People in their 40’s most likely are married, have upgraded their home, have a few children, and have nice cars. They have a standard of living they are used to. If something happens and one of them loses a job, it is hard to lower your standard of living. It’s easier for a person in their 20’s to do so, simply because they have been living on less for a few years. But as we age and get accustomed to our lifestyle, it is hard to reduce it.
- According to the article, the typical household nearing retirement has $120,000 in retirement savings. That amount of money is going to last at most five years. I say this because most people underestimate how much they actually spend. If you have this amount of money and retire at 65, what are you going to do when you turn 70 and have no money?
Mandatory Emergency Funds
One person interviewed in the article stated that the number of people that takes out a loan shows that workers would rather have the cash than be forced to save for retirement. Part of me agrees with this and the other part doesn’t. The part that does says that maybe employers should first set up a trust-like account with an employee. For the first five years, the company will match 3% of the employee’s pay into this fund. It will be an emergency fund and when the balance reaches a target amount or five years, then the company match goes towards the employee’s retirement plan. The trust-like account cannot be accessed for those five years.
The part of me that is against this says that giving employees cash instead of a match for retirement doesn’t address the real problems: first, people live beyond their means and second, they don’t save enough for retirement. Living beyond one’s means is not the employer’s job, so they should not be forced to make sure an employee is living within their means. Also, if you do not match or otherwise encourage employees to invest in their 401k plan, they lose their greatest asset, time. The longer they wait to start saving, the more they need to save.
What’s the answer? I have no idea. People have to want to be financially stable. Many say they do, but then they go stand in line for the new iPhone because they HAVE to have it. Until people truly want to become financially stable, I don’t think there is any hope. Maybe the answer is to scare people into saving for retirement. I remember back in high school going to a mandatory presentation on drunk driving and smoking and drugs. They would show images of the aftermath of drunk driving accidents and people that smoked and had cancer would speak along with ex-drug addicts. The idea was to scare us into not doing any of those things. Maybe we need a mandatory meeting on people living in poverty and how hard their life is and how their lifespan is shorter than others to scare people into living within their means and saving for retirement.
Readers, what are your thoughts on so many people taking loans from their 401k? Is there anything that can be done to make people understand doing so is a bad idea?