Oh, the attractive 401(k) loan. You can borrow money, regardless of your credit score, and when you pay it back the interest is being paid to you? Sign me up! Except, wait a minute… there has to be a catch, right? Yes, there is a catch, a very big catch, several in fact. During the length of the loan you will be losing out on any interest that would have accrued on the loan amount, had you kept it in the 401(k). Not only that, but you’ll end up paying taxes on the money twice, once when you take out the loan and again when you take out the money for retirement. Oh, and don’t forget if you are let go or you leave your current company, the loan is due in 60 days. Bummer.
Yet despite the many, many cons to taking out a 401(k) loan, they are actually on the rise. I’ve recently come across two corporations who each had a 401(k) loan rate between 24-27%! This is extremely high! This means 24-27% of their employees aren’t going to have the retirement they hoped to.
So what is the alternative? You want your employees to be healthy and happy, yet there is a 100% chance if they are taking out 401(k) loans they aren’t in a good financial place. It comes down to people being desperate. A 401(k) loan is a cry for help. It means you are in a desperate situation and you need money now. This isn’t good for any employee, or employer. The best way to prevent future 401(k) loans, and to heal the financial wounds created by taking one out, is to educate your employees. By teaching your employees to budget, cut expenses, pay off debt, and save for an emergency you can help them make the best choices for their financial lives.
What is the 401(k) loan rate at your organization? What, if anything, does your organization do to discourage these types of loans?
Peter Dunn a.k.a. Pete the Planner® is an award-winning financial mind and a former comedian. He’s a USA TODAY columnist, author of ten books, and is the host of the popular radio show and podcast, The Pete the Planner Show. Pete is considered one of the foremost experts on financial wellness in the world, but he’s just as likely to talk your ear off about bass fishing.