Thursday, October 18, 2012

Borrowing from your 401(k)-Good idea? Bad idea?

Your 401k is a multifaceted financial tool. Not only can it save you money on taxes as it defers income tax on the money you save for your retirement, it can also play an important role in purchasing a home or even help you get out of debt. Believe it or not, if you are a first time homebuyer, you can draw money from your 401k or Traditional IRA without penalty. That does not mean you won’t pay taxes on what you draw out, it means you won’t have to pay the 10% IRS tax penalty if you draw the funds to purchase a first home.

Not only can you draw on it for a home purchase, you can borrow against it. You can borrow up to $50,000 or half of your 401k, depending on which is less. When you borrow for a home you get a longer pay back period, up to ten years. If for any other use, you will only have five years to repay. The bimonthly payment will be evenly spread out or “amortized” over the time period and will be taken after taxes from your check. The interest you pay gets reinvested in your account. Your money remains in the account working for you. Remember, this is a loan not a withdrawal.

There are advantages and some major disadvantages for borrowing against your 401k for a home purchase:

  • Advantages: The money in your retirement account continues to work for you when you borrow against it. If you withdraw, you lose any shot at future market earnings.

  • There are no tax penalties for taking a loan out on your 401k and repaying it.

  • The interest you pay goes back into your 401k as a contribution for you and is added to your retirement funds.

  • I have never seen a 401k loan show up on a credit report. You are borrowing your own money so it does not count against your FICO score. Borrowing from most consumer sources will have an affect on your credit report and score.

  • Your monthly payment is taken automatically from your paycheck by your employer and credited against your loan by the 401k trustee.

Some Major Disadvantages

  • If you leave your employer early, they will need to pay off your loan from the proceeds of your 401k retirement plan. It does not matter if you quit, are fired or laid off. The 401k trustee will debit the loan payoff amount from your retirement account and pay off the outstanding portion of your loan. This withdrawal will be subject to taxation and Federal IRS early retirement plan withdrawal penalties. You will pay a 10% tax penalty on the amount withdrawn and also be subject to ordinary income taxes on the pay off amount. Depending on where you live, there may also be state taxes and penalties on a withdrawal such as this.

  • For some plans, when you take a loan against your 401k, you may not be able to make contributions for the time your loan is outstanding. Meaning that your retirement savings will stop until your loan is paid off. Check with your trustee for details.

  • You are also repaying part of the loan with money that has already been taxed. As you know, one of the benefits of contributing to a 401k is the fact that the money is invested pre-tax. When you take a loan you aren’t taxed on the proceeds, but the money used to repay the loan has already been taxed so your additional interest going into the account will effectively be taxed twice–at the time of contribution and again when eventually withdrawn from the account in retirement. Ouch!

Most Human Resource professionals will counsel you not to take a loan on your 401k for the very reasons I described above. Not everyone stays at the same employer for 5-10 years. In the U.S., employees tend to last 4.4 years on the job according the Department of Labor Statistics. Younger employees last shorter amounts of time and older employees may stay on longer. The bottom line is that very few Americans remain on the job for the full ten years it takes for one of these loans to mature.  

You need to consider many variables when thinking of taking money from your 401k either as a withdrawal or as a loan. Some of the questions you need to ask are: How much do I need? What is the penalty if I withdraw it? How much are my taxes on that withdrawal? What is my advantage in taking out a 401k loan? How long do I plan to remain at this workplace?    

 *    *     *
Oct. 24th  - 6:30pm
Free Financial Workshop
Credit Myths and Repair
Sunnyvale Financial Center at Fair Oaks and El Camino Real in Sunnyvale. 
RSVP with

Thursday, October 11, 2012

Moving and Credit

There are some things that can happen to our credit when we move and it can be very troubling. Lost or misplaced statements may mean missed bills. On utilities it is not so bad as we typically have a couple of months to pay our cable or water bill. However, our credit runs on a 30 day cycle and missing a payment on a Visa card can hurt our FICO score pretty dramatically. There are some tips below for getting your mail forwarded properly.
When we move, we buy a new home and may go to multiple lenders to access a loan at good terms or we may have multiple inquiries for rental housing. Typically, those multiple inquiries from home lenders will be treated as one inquiry for our scoring. They will appear as multiple inquiries on our credit report and will remain there for two years but only have an effect on our score for one year. Inquiries comprise only about 10% of our total FICO score.

Another thing we do when we move is close accounts. A bank may be a regional bank, but its Visa or Mastercard is accepted worldwide. There is seldom a need to close a VISA or M/C unless the terms are unfavorable. Closing these cards reduces one’s credit score and your borrowing capacity; sometimes eliminating years of experience from a record. Be selective and careful when considering closing a credit card. Consider closing a card if a card has a small line of credit or is related to a regional or specialty store that is not available in your new town.

Clean up your old records before you move. This is a good time to shred old records and prevent ID thieves from getting their hands on them.

Here are some mail forwarding tips:

Before you move:
  1. File your forwarding address with the post office at least two weeks before you move. Not only does this get your bills and statements sent on to your new home it prevents identity theft. Old statements in a mailbox are like candy to an ID thief. The post office will mail a letter to your old address to verify this change.
  2.  While you are at the post office, get a change of address kit from them. Sit down at home that night and send a change of address to every company that sends you a statement or a bill. Some statements only come quarterly so be sure to check. Make sure you have the effective date of your move correctly entered. With some bills, creditors and financial institutions, you may be able to change your address online or over the phone. Note on your list who you called and to whom you sent a notice.
  3. During your move: Ask a neighbor, landlord, or friend to check your mailbox to ensure the forwarding and address changes went thru and pick up any mail that does not get forwarded.
  4. After your move: Contact the new tenants or homeowners and provide them with you contact data in case any of your mail fails to get forwarded in the future. 

*     *    *

Our next financial workshops are:
Oct. 17th  - 6:30pm
Real World Budgets for Teens and College Students
Sunnyvale Financial Center at Fair Oaks and El Camino Real in Sunnyvale. 
RSVP with

Oct. 24th  - 6:30pm
Credit Myths and Repair
Sunnyvale Financial Center at Fair Oaks and El Camino Real in Sunnyvale. 
RSVP with

Thursday, October 4, 2012

Does Good Debt Exist?

Good debt does still exist. Home debt, if you are not dramatically underwater is still good debt. Please remember that the majority of home owners have seen some degradation of their equity, but most homeowners are not underwater. The generally accepted number is somewhere between 20-25% of all homeowners have a home that is underwater. Most of these were either purchased or refinanced during the recent boom in prices, especially 2005 to 2008. It is a simple truth that 75% or more of all U.S. homeowners are not underwater. Homes purchased today with a reasonable downpayment of 20% or more may have some stagnant price growth in the near term, but historically, owning a home is a sure path to wealth creation. When you consider the tax advantages of owning a home and the increase in value even if it only follows regular inflation rates, new homeowners will incur good debt.

Is college debt good debt? Many are of the opinion that education is important and the resulting debt from financing it is still a good debt. That is provided the student finishes and graduates. Statistics show that lifetime earnings of those with bachelors and masters degrees are substantially higher than those with only a high school education. I have many former college students in my workshops who have not graduated and have substantial student loan debts. Those debts become good debt and will be well worth it when they finish their degrees.

Is all credit card debt bad debt? Not necessarily. Often, young persons will use a credit card like it is going out of style. They will pay for movies, dinners out, concerts, and other fun items with their credit cards. That is some bad debt; debt where you have little or nothing but memories to show for it. I think the responsible use of credit cards is in purchasing assets for your home or car. Use the card for furniture, needed appliances or a major car repair. That way, when you are on your couch writing a check for your Visa card payment, you are sitting on your asset. (A little finance humor.)

Vehicle debt can often be termed good debt. Your car is an economic development vehicle. It gets you to work on time and gets your kids to school. Is spending 2 hours plus on a bus or train daily the best use of your personal time? It is a matter of opportunity cost. How much is your personal time worth?

In the end, I think that the difference between good debt and bad debt is subjective. Our income, education, and cultural background all play a role in how we view the value, really the personal value, of our debt. 

*   *   *

Our next financial workshop:

Today's Real Estate Market and Tips for Purchasing Foreclosed Property
Saturday, October 13, 2012 - 10:30 a.m.
Chesbro Financial Center, San Jose, CA