The following questions have been edited into a Q&A format and some details may have been changed to keep our listeners’ information anonymous. Let us know what you think in the comments below, or if you have your own question, use the ASK P&B button!

When the average U.S. home has a total of almost $135,000 in debt with $17,000 of that amount on credit cards alone, it’s no surprise that many people are considering 401ks loans or using an early withdrawal to pay off their bills and debt. Our listeners are no different. Below are a few questions we’ve received on this topic and why we think 9 times out of 10, a 401k loan or choosing to early withdrawal from your 401k are expensive, bad personal financial decisions.

Question #1: Hi Rich and Marcus,

Love your show and need some advice. I am in credit card debt and want to pay it off as soon as possible. I am up to date with all payments but I’m only left with about $50 a month due to the high APR’s. FYI, I do live on a budget but I live in San Fran and have no wiggle room.

Thus, I wanted to ask if I should I take a loan out from my 401K account that would pay off all the debt with an interest rate of 2.37% over 4 years and I would save about $200 a month? I know that I will loose money in the long term on the retirement account but I will have the debt paid off in 4 years vs. 15 years. Also, I am in my 30’s so I will not be touching this account anytime soon.

Thanks in advance for your advice.

The Cons and Cons of a 401k Loan

On PB56: The Truth About Credit ft. Liz Weston, Liz — a Certified Financial Planner (CFP) — estimated that for every $1,000 you withdraw in your 20s, you can cost yourself up to $20,000+ in lost compound interest and savings when you reach retirement age. While I sympathize with the paycheck-to-paycheck struggle having been there myself before, there are few immediate scenarios I can think of that justify losing $20,000. If you have a good-to-excellent credit score (730+), you might be better off applying for a credit card with a 0% balance transfer. Keep in mind there will likely be a minimum balance transfer fee (usually 3-5%) and you’ll reap the maximum benefit by paying off or down the debt during the 0% period.

Another option, if you’re going to use a loan, is a Peer to Peer (P2P) or consolidation loan rather than borrowing against your 401k. You’ll pay more in interest in the immediate future (6.99%+ APR for an excellent credit score of 750 or greater), however, you can still reach your goal of paying off your debt in four years and some unsecured personal loans will allow you to borrow up to 60 months, which might help you find additional savings and cushioning month-to-month.

An additional risk of a 401k loan, as our listener faced in Question #3 below, is if you lose or leave your job, you may have to pay the money back immediately regardless of the original loan terms. You’ll also have to count the loan as taxable income for the year and pay the associated tax penalties, which can be pretty steep (up to 25%, or more in some instances). This is an extremely high and unnecessary risk to take for an outcome you can’t predict and might not have control over. Conversely, some P2P companies, such as SoFi, have pre-negotiated deferment options built into the loan agreement just in case you face a job loss or have difficulty making payments during the loan period.

Major Key: In all of the above scenarios, I recommend you first research all of your options, then apply. Each option above will require a hard credit check that will temporarily lower your credit score. Choose the best option for you and do not apply for more than three in any given month. If you do not qualify for your preferred option, continue your positive payment habits and try again no sooner than 90-days to ensure your credit score doesn’t take a major hit.

Question #2: Hi Rich & Marcus! How are you? I recently came across your P&B podcast (where have I been?) and it’s easily one of my favorites! You guys are so great.

Nearly two years ago, I relocated to Los Angeles for a new experience and with the goal of working in the entertainment industry. Since moving here, I haven’t landed a full-time job and my part-time independent contractor position barely makes ends meet. My lease renews in four months and I am contemplating moving back home to live with my Mom. My Mom, on the other hand, suggests I take money from my 401K to give myself another year to “make it” so that I don’t regret giving it the “old college try.” I don’t agree with this method. I’m 30 years-old, I nearly wiped out my five-figure savings for this move, and am in debt due to credit card charges and having to pay taxes. I’m (obviously) not getting any younger and I’m ready to rebuild financially, however, I don’t want to move back home prematurely. I’m sure I will have more room to breathe (and save and pay taxes) once a full-time job comes into play, but the cost of living in Los Angeles IS high and who knows when a full-time job will come. I absolutely love living here, but I also want to play it smart. Do I struggle now and (possibly) ball later?? I would love to hear your thoughts!

Thank you for reading my question and I truly appreciate all you do!

Struggle Now and Ball Later

You’re right: I don’t agree with the method recommended by your mother. Also, don’t tell your mother I said that! I’m a writer, not a fighter.

I’m not saying you have to move back home; I’ll defer to you on that choice. However, borrowing against your 401k is the worst option here, especially after considering that you’ve already wiped out your savings for the initial move. At best, if the option and energy exist, you’ll be better off working a part-time job or a side hustle to make additional income if you want to give yourself another year. If you borrow against your 401k, you’ll only unnecessarily put your retirement savings at risk.

Question #3: Last year, I was working for a healthcare company and they had a 401k plan that included an automatic 401k plan, I did all the right things, I contributed and even raised my contribution rate. But unfortunately, at the end of the summer, my company decided to sell the building we worked in, which subsequently led to a layoff of the entire building staff. They did pay us for 90 days afterward because of some law, but eventually, the money stopped. I have found employment elsewhere. Which lead to me “forgetting” my old 401K, until I received an email from the company holding my funds. So now I’m stuck in between cashing myself out with the accumulated funds $3,864.21, or should I just roll it over into another 401k/ Roth IRA situation.This information would be really helpful, I’m currently back in school full time, living with family full time. I just want the money to be used as first a cushion, and the rest to catch up on bills because I only work about 16-36 hrs a week.

They See Me Rolling (My 401k)

I’m sorry to hear about the layoff. Hope things are improving. To answer your question: I have (twice) always rolled my 401k over to my next employer. If you pull the funds out you’ll have to pay a tax penalty for an early withdraw. It’s rarely worth it, and after taxes and fees, you won’t get anything close to your full $3,864. In other words, don’t just give your hard earned money back to the government in the form of additional taxes and fees. I’ve also found it helpful for some people to think of their investment in terms of returns instead of the current amount. At a 6% return, even if you made no additional contributions, $3,864 would be worth about $12,392 in 20 years. It’s your money, so you should maximize the benefits gained. Remember, you’re investing in the present to help your future.

I also want to take this opportunity to crunch the numbers for those of you considering a larger 401k loan or early withdrawal. A couple additional considerations:

  1. The IRS only allows you to borrow 50% of your vested IRA account balance or up to $50,000, whichever is less. Generally, you must repay the loan within five years.
  2. As NerdWallet’s Adam Funk, CFP, outlines here, taxes and fees should play a significant consideration in your decision to withdrawal from your 401k. In his example, you would need to withdraw a total of $48,214 against your 401k just to take home $27,000 after taxes and penalties! In most cases, an early 401k withdrawal is a horrible use of your investment because the math is rarely in your favor.

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