Are US Employees committing Hari Kari with their 401(k)?

More and more US employees are borrowing against their 401(k). This is equivalent to a retirement nest egg funds suffering a stock market crash and could be the equivalent of committing Hari Kari with their nest egg. Taking funds out of the 401(k) depletes your retirement nest egg and is almost the same as the stock market suffered a major loss.

This is because that money is not in the 401(k) anymore helping the compounding of the capital over time. That $30,000 can no longer compound itself to help grow your funds. Only the $30,000 remaining is now working for you.

It breaks Rule #1: Avoid Large Losses (in retirement) but in this case while working.

Okay I know you have the money in another account to pay for whatever you borrowed the money for. Unless you are re-investing it to get a return somewhere else you are spending it by definition. Make no mistake it will seriously affect your final nest egg amount. The National Center for Policy Analysis has done some work on this phenomenon and it is not a pretty picture.

They claim a $30,000 loan could cost a worker more than $600,000 in retirement income. imageTake a look at the chart.

If you look at the chart on the right taken from the NCPA site you can see the affect of a $30,000 loan taken out over two years and another over five years with the resultant retirement nest egg amount being the white bar. The brown bar is what you would get if you didn’t take the loan.

A loan must be paid back within 5 years or there are serious penalties. And it is harder to pay the loan back because you are taxed before you make a loan repayment.

You may also be hit by the fact you cannot contribute additional money whilst paying back the loan. The impact this may have is if your employer was matching your contributions you will lose his contributions also.

As far a protecting your nest egg goes this is a cardinal sin, a self-inflicted wound. It may even lead to you committing 401(k) Hari Kari? There may be circumstances where it is just unavoidable. But please explore every other avenue before taking money from your 401(k).

Another astounding observation from Daniel Gross’s article called 911 for 401(k)s is about 30 % of employees don’t even contribute to a 401(k) and many are unaware their employer will match their contribution up to a limit. This is FREE money 😉

So find a way to match your employers contributions if they make one to grow your 401(k) faster. It may be hard but the more you can put into it in the early years the more money is available to compound and for longer. This will give you a much large nest egg than adding more to it later in life. And you may be able to retire 10 years earlier or at least have the choice of doing so.

The NCPA has a PDF called the “Ten Steps to Reforming Baby Boomer Retirement” which was published in 2006 and is quite critical about the lack of action by the authorities, the employers and the employees to plan for the employees retirement.

However I do not completely agree with Step 2: Improve 401(k) Plans.

“More than half of all workers invest in a 401(k) or similar savings vehicle. But not enough people are investing appropriately for their future. They either do not invest enough or they pursue investment strategies that will not provide an adequate retirement income. To correct this problem, employers should be given a safe harbor against lawsuits and receive other regulatory relief if they automatically enroll employees, escalate the employees’ contributions over time, invest in diversified portfolios, follow an investment strategy that becomes more conservative as the employee ages, and convert the funds into an annuity at retirement — unless the employee specifically opts out.”

I do not think anyone should be given safe harbor against lawsuits especially with someone else’s money. It would be better to legislates that employees have to contribute a percentage of their income each month to a 401(k) from which they cannot withdraw it unless there are compassionate grounds. I’m also against the employer having anything to do with the 401(k) apart from paying into it by law each month.

The IRA’s and 401(k) should be brought into line and employees given a choice without penalty as to where they want to place their funds.

They also imply an investment strategy that will most likely be in high fee mutual funds with no guarantee to protect the capital. But that’s a battle for another day.

Lastly I don’t agree with just converting the fund to an annuity. They do say though the employee can opt out. It is the employees money and they should be able to invest it how they want. Generally an annuity basically gives the money to an insurance company and they pay you until death. If you die early they keep the rest of the money. Not only that standard annuities tend to have high fees and no protection against inflation. Just rolling over from a 401(k) to an annuity without proper review is another case of committing Hara Kari to my mind.

4 Responses to “Are US Employees committing Hari Kari with their 401(k)?”

  1. […] Nikki Leigh – Author wrote an interesting post today onHere’s a quick excerptThis is equivalent to a retirement nest egg funds suffering a stock market crash and could be the equivalent of committing Hari Kari with their nest egg. Taking funds out of the 401(k) depletes your retirement nest egg and is almost the … […]

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