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What to consider before raiding your 401(k)

By Paul Nelson | Posted - Jan 21st, 2013 @ 7:50am

SALT LAKE CITY — Recent reports say one out of four people are borrowing money from their 401(k) retirement accounts to pay for monthly expenses. Financial counselors say people need to know how this will affect them before they do it.

When it comes to borrowing from your 401(k) plan, some financial counselors say it should be avoided at all costs. Others say it's sometimes necessary when people need emergency cash.

If you're considering doing this, there are a few steps you need to take before it happens.

AAA Fair Credit Foundation President Preston Cochrane said, "When it comes to paying off debt through a 401(k), what someone should first do is analyze their overall financial situation and try to determine what caused them to go into debt in the first place."

  • Find cause of debt
  • Spend from savings account first
  • Sell assets if possible

Cochrane said people need to see where their money is going before they borrow from their retirement account.

"It's a lot like trying to bail out a sinking boat without first plugging the leak," he said.

Cochrane said borrowing from your account isn't necessarily a terrible thing to do, but you will be subject to additional taxes, and you will take a big hit on the interest you collect.

"When you pull that money out, you're reducing the amount of money that can compound," he said.

Plus, if you default on this loan, you'll have to pay a stiff 10 percent early withdrawal fee.

In 2011, Cochrane said it would be a much better idea to take money out of a savings accounts instead of a 401(k) to avoid the tax hit.

He also advised selling some assets if possible rather than resorting to borrowing from the 401(k).

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