Can You Have Your 401kake and Spend It Too?

By Matthew D. Hutcheson, an independent fiduciary and a nationally recognized authority on qualified plans and fiduciary responsibility. He is a Certified Pension Consultant and an Accredited Investment Fiduciary Auditor™. He may be contacted at matt@erisa-fiduciary.com.

Americans love 401k plans. We love to watch our investments grow, we love to see the taxes deferred, and we even love the jovial "my 401k is bigger than your 401k" discussions found in many break rooms around the Nation.

401k plans are relatively new, unlike the tried and true Defined Benefit plan. In fact, there are very few retirees who are living off of their 401k plans (relatively speaking). This is because 401k plans have not been around long enough to accumulate the large balances required to provide a permanent, substantial income stream. Irrespective of this, 401k plans will most likely be the primary source of private retirement income to most Americans within the next 20 years. Yet unbeknownst to most, there is a thief who is robbing hundreds of thousands of 401k participants of their future.

This thief is the participant loan. He has robbed most of those closest to us through his clever and flattering techniques. He steals the potential for large gains on liquidated assets, in some cases He blinds eyes with the lure of tax-free cash for the boat, the car or many other non-necessities. He assures us that all interest is paid back into our own accounts, giving a sense of justification and pride. You see, he knows we love our 401k plans and that we would never consciously do anything to jeopardize our future financial security.

To have a secure financial future, one must wisely save and invest. The irony of this is that many will not participate in a 401k until they are assured they can access their money if needed. Yet, not long after a 401k has grown to a respectable size, the thief comes with as much predictability as political promises on election year to satisfy an immediate want (or need) with an enormous cost in the future. The deceit is that you can have your 401-kake and spend it too.

It is estimated that 80% of all 401k plans have loan provisions in them. It is estimated that 15 Million Americans have taken a loan from their 401k plan. How can something so common be that bad? Loans really can’t be classified as "bad", unless you see them as the destroyer of your future financial security.

Let’s explore a hypothetical scenario. Chuck is a normal American guy with a good job and a 401k. In 1996, his account balance was $15,000 and he was contributing $200 per month or $2,400 per year. Chuck has chosen to invest in the Growth Fund offered in the plan, which is performing quite well – averaging a return of approximately 15%. In 1998, Chuck decided to take a loan from his 401k worth $12,886 to help pay for one of his children’s first year in college. He thought that since he will pay it back to his own account with interest it would make great sense. What he did not take into account was the effect of losing significant growth on nearly half of his account. He will learn that the loan payments will never be able to compensate for the lost growth opportunity. We will see that in Chuck’s case, the lost appreciation on his account will cost Chuck hundreds of thousands of dollars.

As we continue on our journey with Chuck, we see that he pays off his first loan in 2002 but like many plan participants, decides to take another loan of $40,000 to remodel his house in 2004. Finally, after paying off his second loan, he takes a third loan of $20,000 to pay off some accumulated debts. The following grid lays out how his account evolves over the years.