How to Use Your 401K to Consolidate Your Own Debt and Live on One Income

Conventional wisdom tells us never to touch our 401K accounts until retirement – but conventional wisdom, as we know, can be wrong. So when might it make sense to withdraw your hard-earned savings before retirement? Conventional wisdom, again, would probably tell us to take it out only in emergencies. But there are situations when it makes sense to take out a 401 K loan, and when it may be a better choice than your other financial options.Ã?¯Ã?¿Ã?½

But first things first: you must have something to borrow from. Are you contributing to your 401K plan? Here conventional wisdom is right: you should be contributing as much as possible. You may be able to contribute as much as 25 percent. Many peopleÃ?¯Ã?¿Ã?½might not be able to set aside that much out of each paycheck and still pay their bills.Ã?¯Ã?¿Ã?½But if your employer offers a full company match of say, 4 percent, you should contribute at least that much. For when you contribute that 4 percent,Ã?¯Ã?¿Ã?½you are actually saving the equivalent of 8 percent of your check. And because you’re contributing to a 401K, your contribution will not be taxed until you retire, reducing your taxable income – and your taxes – until then.Ã?¯Ã?¿Ã?½

But let’s suppose you know all this and have been contributing to your 401K plan on a regular basis. You now have a balance from which to borrow. When should you borrow from it?Ã?¯Ã?¿Ã?½

Emergencies, of course – medical needs, car repairs – anything your regular paychecks or savings cannot handle. On a more positive note, you may instead want to borrow when you buy a house. Let’s face it, for many in the middle class, there may be no other way to raise enough money for the down payment. If your 401K plan is anything like mine, there may be special terms for housing loans that do not apply to loans taken out for other purposes. For example, your borrowing plan may specify that you can take twice as long to repay a housing loan as a general purpose loan. That can make a big difference in your ability to repay it. You don’t want to whittle away your take home pay until there’s nothing to take home. In recent years, we’ve all heard stories of those who’ve overspent on housing and lose their houses. You don’t want the repayment of your 401K loan to be part of the problem.Ã?¯Ã?¿Ã?½

So those are the obvious times you want to borrow. But there are less obvious instances that may be just as important. Certain major life changes, for example. No, I’m not taking when you leaving your job-if you do that your company may require you to repay it all back at once, for one thing. The life change I’m talking about is – children, who change our lives in so may ways already.

When we had our first child, we were faced with a choice-do we farm him out to a babysitter or day-care for the next several years or can one of us stay home to raise him? My wife wanted, above all else, to stay home and raise him – wanted to get to know him as only a mother can. But because of our debts we didn’t think we could afford to have her stay home – we had far too many monthly payments. What could we do? His life was passing by oh so quickly, and it was hard on us both working and trying to take care of him. It was wearing us down. (We were quickly finding out just how little a brand-new babyÃ?¯Ã?¿Ã?½sleeps at night.) Like most working class families, our savingsÃ?¯Ã?¿Ã?½accounts were not that big, except for the amounts we’d been able to save in retirement plans (who wants retirement to be as difficult as the working years have been?)

But when our babysitter announced she was returning to her home state, the decision was practically made for us. We borrowed from the 401K and paid off enough debts to cut our monthly expenses by about a third. Gone were the credit cards, one small loan, and several other debts. We even paid off our car loan about 4 years ahead of term. We retired all the main monthly payments except, of course, utilities, the mortgage (just too big), and student loans (which seem to last forever no matter what you do).�¯�¿�½

We radically redid our finances with our 401K, which we are now paying back to ourselves at an interest rate higher than current market rates. A 401K loan is not an ideal situation, of course, because it may keep the retirement account from growing quite as fast as it might have. But it was the best available choice at that time. My wife was able to quit her job without too much worry. Now, despite the reduction in income, our finances are actually much better. Even if there were no other benefits, the reduction in our level of stress made it worth it.�¯�¿�½And, most of all, my wife can now stay home to raise our child.