What You Should Never do with Your 401K

What do a leaky roof, college tuition and a failing transmission on your car have in common? Probably the same thing a remodeling project, home renovation and medical bills, too.

These aren’t the lead in to a bad joke, but rather hardly anything worth laughing over any time soon.

They’re expenses, mostly of the unexpected variety, and they often lead to panic if you’re not prepared with cash on hand, and a savings account that is all too prepared to take care of whatever the cost might be.

Even if that cost means you might have to mortgage the future on expenses.

That said, the average person doesn’t have a whole lot saved in that “nest egg,” and thus have to look toward another means of paying, aside from racking up debt, borrowing money or adding to their already growing list of credit card debt.

The average American, under the age of 35, only has about $1,500 saved, and even if you’re in a higher income tax bracket (making at least $70,000 up to $115,000, you’re still only setting aside, on average, about $5,400.^[1]

That isn’t exactly a lucrative proposition when you consider the cost of a new transmission is between $1,800 and $3,400.^[2]

Add to that the cost of a college education, broken down over four years, is between $23,000 and $34,000.^[3]

The $5,400 barely would cover a year’s worth of books.

These figures aren’t meant as a deterrent but rather the harsh truth that you aren’t savings as much as you need, and when money is needed from some source, you look elsewhere, good or bad.

Also, when it comes to a 401K, it’s also about managing it properly, knowing how to maximize contributions, and that also plays into the discussion about what to do and what not to do. Far too often, the masses treat their 401K like an extension of their bank account more than its intended purpose: money put aside so that you can retire comfortably, not a means to dip into at a moment's notice.

And with that, comes the 401K, your retirement account, and the money that has been sitting there, waiting for the day you call it quits, only to be trifled with at a moment’s notice, in that moment of weakness when you aren’t sure what to do when unexpected costs arise. Another piece of this centers on those individuals and families alike who are using their 401K for reasons that are hardly advisable, and this goes far beyond the practicality of car and home repairs, braces for the kids or the would-be college tuition on the horizon.

This is more about haphazard spending, reason that you’re borrowing from your future that hardly would be advisable.

Keep in mind that the average 401K balance hardly knocks your proverbial socks off: it’s around $97,700 overall, with ranges between $9,900 for ages 20-29 all the way through to $167,700 for ages 60-69, again hardly numbers that are in line with what you’ll need to potentially retire comfortably.^[4]

While at least that’s something in your 401K, consider that 42 percent of the population also is on the verge of retiring with nothing saved at all for retirement.^[5]

And that’s where this conversation about what to do and what not to do with your 401K takes on an interesting skew: should you be doing anything with your 401K, and furthermore when is it acceptable to spend it? While some argue that using your retirement for certain purchases, down payments and other endeavors makes sense, you also can make the same statement that this is money that should be left alone, not to be used under any circumstances.

Before you determine which side you’ll land on, keep in mind this isn’t a discussion that ends with the meandering commentary “there’s no right or wrong answer.” Respectfully, that is a statement underscored with an illogical perspective on how you should view your financial future.

There are right and wrong ways to spend your 401K, and here’s a snapshot of what not to do with the money that is meant for your “Golden Years” exclusively.

Don’t: Pay Off High Interest Rate Debt

So this one has it’s good and bad points to it, and should be entered into knowing what makes the most sense.

Anyone who has high interest credit card debt knows how that feels to truly never get ahead.

You make payments, the interest rate is overwhelming, and you can’t make up any ground, or if you do it’s minimal at best.

When you borrow from your 401K to pay off debt, you have to assume that you can make up the difference because you earn enough money to do so. Loans are a little different than early withdrawals (more on that in a minute) because you pay the loans back, so they’re not subject to an early withdrawal penalty.

That said, you shouldn’t be borrowing from your 401K to pay bills or even debt (you’re eligible to borrow approximately half of your balance, up to $50,000) if you can’t pay back the loan, and also contribute more on a pre-tax basis; 11 percent on average borrow from 401K, with 22 percent currently holding a loan amount that is due.^[6]

Loans are tricky, however, because if you take one out, and would leave the company, you’re responsible for it, and the payment plan is compromised. Most loans need to be paid back within 60 days upon leaving the company, a tall task depending on the size of the loan.

If you’re not prepared to pay that back, which why would you be since you took the loan out in the first place, that could become a dicey and disruptive financial dilemma for you.

Another element of borrowing from your 401K, despite the fact that a loan isn’t counted against you, means that while you are paying yourself back rather than borrowing from a bank, you still are taking money out that has a better chance of being invested properly and thus earning more within the friendly confines of the 401K itself.

Don’t: Ignore Your Contribution Amount

The first subheading focused on spending money from your 401K, but what about, as talked about previously, managing the account better.

Far too often, individuals simply set a total amount, and then ignore the percentage that they’re contributing for years, only finding out at a certain point in their work career that they are well behind their savings goal.

Sure, once you hit 50, you can make contributions above and beyond the maximum, up to $24,000 per year to get back on track.^[7]

But who wants to do that?

Instead, as you start to get raises each year at work, even if they’re cost of living raises alone, or earn a bonus, etc., you should consistently increase until, at minimum, reach the company match percentage.

On average, you should be saving between 10 and 15 percent into your 401K, but most company defaults are around the 3 or 4 percent mark, woefully short of where you want to be.^[8]

Being proactive with your retirement account really makes quite the difference, so sitting back and setting a number one year after another is going to lead to a massive shortage when it is time to say so long to work.

Don’t: Leave a job without Rolling it Over

One extremely common misstep with a 401K occurs when you leave a position or company, and have money sitting in a 401K account.

While it’s easy to assume that money should be cashed out while you either look for another job or because it’s simply “there,” you’re not going to want to go full-sale spend on it, either.

This is not found money, but rather a means to take what you’ve saved for retirement and simply continue to build upon it.

Almost 50 percent of people take their 401K balance and cash it out.^[9]

The example stated as part of this plea has a $200,000 cash out that winds up putting only $124,000 in your pocket, mostly due to losing $56,000 to taxes and another 20 grand in penalties.

As lucrative as it may seem to take the money and run to another job, you’re actually doing yourself a disservice by cashing out.

That $200,000 in the above example would inch closer to high six figures, nearly seven figures, if you roll it over at anywhere from a 6 to 7 percent return.

You don’t have to be a math whiz to realize that nearly one million dollars and a little bit of patience and common sense, financially, is better than $124,000.

The other piece of rolling over an account into an IRA that works for you: it allows you to have a better control over the money overall.^[10]

You can assume that “rolling it over” also can mean putting the money into a 401K at your new job, too.

No matter how you look at it, the better bet is to put it somewhere other than under your mattress (aka in your bank account).

How many people want to retire and do so on their own terms?

Well, about 24 percent of the population is fearful that they’ll never (that’s right, not now or ever) be able to retire.^[11]

That’s a large number, and would suggest that being especially careful with your 401K from now until retirement is largely one of the more important financial pieces you can apply focus to consistently.

No one is suggesting that the 401K is virtually untouchable, but it would take a special case to be made to use any of it, much less for the reasons that were previously mentioned.

Financial hardship can play a part in taking or drawing from your 401K, but remember that is a 10 percent penalty when you do that.^[12]

Treat your 401K like the precious entity that it is: once you make the decision to retire, you’ll have a hard time coming back out into the workforce for fear that you’ll run out of money.

And then, you’ll continually, should that happen, question why you made the decision to dip into your 401K when ignoring it altogether might have prolonged your retirement, and changed it from temporary to permanent.