I firmly believe every savvy investor should know how to access all the money they control, including retirement funds.
“Hold on– shouldn’t I leave my retirement account alone until I turn 60?”
I say NO!!! Use it to help you retire earlier! That’s what I’m doing, and I think anyone attempting to retire early should be doing the same.
Why Borrow From My 401(k)?
Want to retire early?
The current threshold for withdrawing from your retirement accounts without paying early distribution penalties is 59 1/2.
That means the money in your 401(k) is not helping you reach your goal of early retirement.
Why not use that money to invest in something that can get you closer to financial independence?
Let’s find a way to turn those seemingly “untouchable” funds into positive cash flow.
When you loan yourself money from your retirement fund, you sell shares of your retirement portfolio. That money is now out of the stock market and in your pocket. That’s money you can use to invest and increase your personal cash flow.
But there are other reasons to borrow from your 401(k):
- You expect the market to take a downturn and don’t want your money invested
- You expect the interest paid on your self-loan (about 4-5%) to outperform the market
- You can invest the loaned money into something else that outperforms the market
- Your employer offers a company match and you want to consider taking advantage of that while also lending yourself money for investments (this is what I’m doing)
Here’s an example of the company match situation:
Your company offers a 100% match on your 401(k) contributions up to $1000.
If you were to forgo your contribution and not get the company match, you would have $1000 minus taxes –or something like $750– to invest.
If you were to take advantage of the company match, you would end up with $2000 of pre-tax money in your 401(k).
Rule: You can only loan yourself 50% of your vested value or $50,000, whichever is less.
In this scenario you could loan yourself $1000.
That gives you 33% more money to invest. It’s important to note– you do have to pay interest on that money; however, all the interest goes back into your 401(k).
The Rules of 401(k) Loans
By this point you may be itching to dip into your retirement account but let’s look at some important rules:
- You can loan yourself 50% of your vested value or $50,000, whichever is less.
- You are automatically approved for a loan. There is no qualification process.
- The loan term is five years or less.
- If you fail to make a payment, the remaining loan amount will be treated as taxable income for that year and you will also incur the 10% early withdrawal fee.
- Loan payments are typically deducted from your paycheck.
How Do I Get The Money?
Most 401(k) providers have a secure web login that offers a path to request a loan.
You can request funds to be distributed by check in the mail or by direct deposit.
If you have specific questions or need assistance with obtaining a loan, contact your 401(k) provider.
What Happens If I Fail To Make A Loan Payment?
In most cases your loan payment will simply be deducted from your paycheck, so there’s not much risk of being unable to pay.
What happens if you either get fired or you take another job?
You may be asked to pay the remainder of the loan in full within 60 days if you have a change in employment.
If you are unable to pay back the loan, the IRS will treat the remaining balance on your loan like income for the current tax year and will add the 10% early withdrawal fee (if you are younger than 59 1/2).
The same thing happens if you are unable to make a payment for any other reason.
Should I Actually Do It?
There are two good reasons to give yourself a loan from your retirement fund, in my opinion.
#1: You think you can invest that money in something that will get a better return on investment than your retirement account investments.
#2: You find yourself in a situation where you really need the funds to make ends meet and the terms of a 401(k) loan are better than your alternatives.
Retirement accounts will almost certainly average less than 10% return over long periods of time.
Good real estate investors and business investors can average 20% or better on their investments.
I can tell you right now- it’s worth it for me.