Pricey Man Cave
Spoiler alert: If you are a person who would never, ever, under any circumstances borrow from your retirement plan, you have my permission to just skip the rest of this column. Thank you for playing. (But you might want to show it to your younger, less-wise family and friends.)
It happened again this week. My stomach is still churning.
I realize… I promise I do… how tempting it is when a big expense arises to pull out that 401(k) retirement statement and let those dollar signs start singing their siren song. And I also know that when I was young, I thought surely I would be dead by the age I am now. Who lives to be that old? I have plenty of time to save for retirement; that’s WAY into the future! Uh-huh.
Here’s what I want any person, young or not-so-young, to really understand, deep down in the pits of their stomachs: retirement money is meant for retirement. Retirement money is meant for retirement. May I say it again? Retirement money is meant for retirement.
Not a believer? Let’s look at Fictitious Joe, who’s 35 years old and has actually done a good job of saving within his company’s retirement plan. He has $100,000 saved and is so proud. And since he’s done so well, he’s decided to reward himself with one of those outdoor man cave patio grill thingys that his neighbor (Mr. Jones, of course) has. So Joe borrows $50,000 from his 401(k). After all, this way he doesn’t have to go through a bank and he’s paying himself back, right? (I shudder.)
What’s the effect of that $50,000 reduction on Joe’s future self? First, the $50,000 is, of course, not growing while it’s not in the 401(k). That, alone, assuming a reasonable five-percent growth, could have added more than $17,000 to his retirement nest egg over a six-year payoff period. And because he’s paying back the loan in after-tax dollars, the payback is even more expensive to Joe.
Because Joe is paying back his loan and is not willing to adjust his lifestyle, he is using the money he would normally have contributed to his retirement to pay off the loan, so no new money is going into his 401(k) for those six years. That’s another $60,000 or so (again, assuming 5% growth) not put toward his retirement. So just the opportunity cost of that $50,000 loan hits close to $70,000 extra dollars. Jiminy! And I won’t even go into the future value of those dollars at retirement. Oh, and did I mention that Joe got a great job offer at another company, but had to turn it down because if he leaves his current company, the retirement plan says he has to pay back his loan in full within sixty days?
So poor Joe has a really cool backyard man cave, and I hope he likes it. It just cost him well over $100,000. Surely a reasonable person would realize that this isn’t smart planning? Apparently not. According to the National Bureau of Economic Research, 37% of active 401(k) plan participants borrowed against their 401(k) over a five-year span. To quote Dave Ramsey, “Just because it’s common doesn’t mean it’s smart.”
Borrowing against your retirement plan is sometimes a life saver for a family in dire straits. I don’t mean to cast a critical light on those in impossible circumstances. But my experience has been that “dire straits” has a wide-ranging set of definitions these days. If you are considering borrowing from your company’s retirement plan, meet with a financial professional first to calculate the true cost of your actions. Just maybe there is a better way to enjoy that man cave.
Did I mention that retirement money is meant for retirement?