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401k Loans
And Loaning
it to a Friend
By Daniel Muniz
Below is an interesting question about loaning money to a friend:
Has anyone here taken money out of their
401k? What are your thoughts about doing it? I have a friend
that is in need of some home repairs. She can't get a loan and
has no family. She has a good job, but has not gotten back on
her feet yet from a nasty divorce. I want to help her out, but
how much is too much?
This is one complaint of my soon-to-be ex-husband: I go
too far out of my way to help others. I don't want to take a
loan out on my [home] equity or take money out of my savings.
And we all know that we can't rely on our 401k's to be enough by
the time we retire. Anyway, I’m stuck on what to do. And how
much is too much...
Now I can imagine that with some people, red flags, warning
signs, flashing lights, and even a fog horn must have gone off with
the above question. Granted, the potential outcome is loaded with
terrible consequences and I am also sure that there are plenty of
people who have come across similar situations.
An acquaintance who was once a branch manager at a commercial bank
had this to say:
1. Your 401k will not grow as much as it
could because funds are being lent from it.
2. You are borrowing tax-deducted money and will have to pay it
back with “after-tax” money. Then in retirement, you are taxed
“again” when you begin withdrawals.
3. If you leave the company “before” the loan is paid back (and
you are unable to pay it back), the remaining outstanding
balance is treated like an early distribution (read: taxable as
income):
20% Federal
10% State
10% Penalties
And he also had this to say:
It sounds like you may have more trouble
"saying no" to people.
Someone else had the following to say:
I don't loan money to friends unless I
consider it to be a gift that won't be repaid. Too many times,
you loan money to friends and expect to be paid back, and when
you aren't- well you lose a friend.
I especially wouldn't compromise my retirement savings to do so.
Also, are you going to charge your friend interest? Because you
will have to pay it to the 401K.
Overall, it is a “lose-lose” situation. You lose out on a portion
of your own retirement by taking such a loan. If you had
discretionary income to spare, then that would be a different story
but a 401k loan is just a different animal that is too important to
tamper with.
And all the red flags and warning signs that go off for everybody
else just signifies that you will probably lose that person as a
friend as well losing your money. Yes, the money will help out a
friend in the short-term but is it really worth the loss of a
friendship for the long-term?
As for being able to say “no” to people, perhaps it goes much deeper
than that.
I think that many people have a natural inclination to help a friend
in need especially if the means is either directly or indirectly
available. And there is absolutely nothing wrong with that and I am
certain that plenty of people have helped out friends and
acquaintances with stuff that doesn’t involve money.
I have helped out quite a few people and lots of people have helped
me out in things that did not involve money.
But the means of offering such assistance from your own 401k loan is
not really the best idea because the person that it hurts most of
all is you. But then again, that is also a very personal decision
and I imagine that every circumstance is different so ultimately, it
would be difficult to really say what is right and what is wrong.
As for relatives and immediate family members, that is a different
story.
Blood is thicker than water and it is so much more forgiving. My
parents and my sister have helped me out in the past and I have not
exactly been able to completely zero out the balance. But in the
long run, I know it will balance itself out as I am available for
future situations (perhaps for my toddler son, etc). And I will look
at it as a gift that I do not expect to be paid back mostly because
I feel that I will do anything for my family.
As for friendships, I do not loan out money to friends. And my
rationale is simple:
Loaning money to friends causes amnesia.
There it is. And it is just that plain and simple. Loaning money to
friends is the chief cause of amnesia. And perhaps the only known
prevention of this terrible affliction is to not loan out any money
at all to any friends.
The only thing that I will give to a friend is advice such as the
following:
Give a man a fish and you feed him for a day.
Teach a man how to fish and you feed him for a lifetime.
I noticed that in the original question that the person who needed
the money already has a good paying job but terrible credit. My
advice would be to learn the proven techniques of legitimate credit
repair. Forget the nonsense from the credit bureaus. There are
plenty of licit ways to remove negative credit items and plenty of
people have already done so.
And then my second piece of advice is to exercise “responsible
credit behavior” so that in a couple of years, a decent credit score
can be restored.
So instead of borrowing from a 401k (that is, giving a fish for a
day), use this advice to restore your credit (which is learning how
to fish).
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