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Using your 401(k) as an Emergency Fund? Are you insane?!

by J. Money on Monday, September 15, 2008

my face.Have you ever heard this before? I seriously couldn’t believe i was hearing 2 “adults” talk about this during this morning’s commute. I haven’t been around this earth nearly as long as they have, but I can tell you flat out that it’s a stupid idea – i won’t even sugar coat it.

What i find funniest though, is that i was literally reading the pros and cons about taking out a 401k loan in this month’s Money Mag while these 2 boneheads were discussing it! haha…If i had bigger balls, and weren’t in the quiet car, i SO would have slapped them upside their heads and forced them to read the article. but i didn’t. and now here i am typing my thoughts away in hopes it will find it’s way towards them one day!

Now, before i continue, there ARE times when someone might need to access these 401k funds, but (a HUGE but), it’s generally not a good idea. Obviously if you were in a serious jam and needed money no matter where it came from, then Yes it is an option, but I’d pretend it’s not there unless absolutely necessary.

Everyone has their own idea of an Emergency Fund, but in theory it’s a holding place for liquid funds that can be accessed ASAP in case anything you deem as an emergency comes up.

So the concept of using your 401k here is already shot down considering it would take at least 2 weeks to get your hands on the money anyway…unless it was a SUPER big emergency that you were planning for ahead of time, which really makes no sense. unless you’re a fortune teller, in which case bravo ;)

So why am i, and many others, so against it? Well, to start you get taxed BIG TIME whenever you cash out: You get the privilege of paying the regular income tax, PLUS a 10% penalty on top of it if you’re under 59 1/2. Then, of course, the money is out of your retirement account and will be much harder to build back up as time goes on. Add on that today’s economy and the fact that you’d be pulling the money at the absolute worst time (bear market), and you’ve got yourself a sticky little situation my friend.

Now, the other option it to take a loan out from your 401k. In this case, you’d pay it back on a scheduled timeframe, and all the interest (usually prime + 1%) would go back to yourself too as you’re essentially borrowing from yourself here. A much better option than the above, but still not the best in my opinion. Sure you’d be paying yourself back, and losing possibly only a little over time all depending on the amount you take out and the market of course, but it’s pretty damn risky. The main reason? If you terminate your job (or get terminated), you usually have to pay back the entire amount borrowed within 60-90 days!!! OUCH that would hurt.

So yes, as you can tell i’m not a fan of taking out your 401k money at any point. But again, that’s just me talking about living a financially perfect life :) We all know $hit happens, and sometimes you’re forced to do things to remain afloat. All i ask is that if you find yourself in one of these sticky situations, make sure you do some good research first and come up with a solid game plan.

And for the love of money, PLEASE set up a side account for your Emergency Fund so contemplating it won’t ever occur! I swear you’ll sleep happier at night.

———
Here are some good links if you’d like to read more:
- CNN Money:
Money101 Lesson23: 401(k)s
- BankRate:
Don’t be dumb — don’t cash out your 401(k)
- BudgetsAreSexy:
Some of my other 401k posts :)


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