Robbing Peter to Pay Paul?

There are many things in life that catch my eye and this one scares me.  In a MSNBC article, it discusses the fact that more and more Americans are taking loans out against their 401(k)s and even stopping contributions.  The reasons for doing this are varied, but some are doing it just to keep up with their lifestyle instead of making necessary changes.  That is just scary.

Why would you want to sacrifice your future to live in the present?  Do you plan on dying early?  This is backwards thinking as any sacrifices should be done now, even if it means moving in a down market.

As home prices fall and banks tighten lending standards, more people are doing the same thing: raiding their retirement savings just to get by and spending their nest eggs to gas up SUVs, pay mortgages or put food on the table.

I purposefully underlined the gassing up SUVs comment as SUVs are a luxury and there are many cars out there that are just as well suited for your needs and have better gas mileage, but lack "status".  Chasing "status" will destroy your finances and I see that everyday in South Florida, where BMWs and Hummers account for a large portion of the automobiles.

Charlton and his wife used the retirement money and $7,000 from savings to pay down their credit card debt. They also cut monthly expenses by pawning a diamond ring and selling camera equipment he owed money on. And he's looking for someone to take over his $550 monthly payment on a gray BMW 335i he leased last April.

Need I say more?  Well, yes I do as he makes a very common thought process...

"I made the best decision I could," he said. "I keep hearing about bankrupting your future retirement. But I feel like it's far enough away that I'll be able to save up enough."

The time value of money went from working side by side with him to against him, though he does not realize it.  That is a common problem with Americans all across the country.  Focusing on paying down debts, especially mortgages, can be detrimental to your financial health overall.  Not setting up emergency funds and doing other financial planning is what leads to these problems to begin with. (check out my "Flight Planning Your Retirement Series")

There is also an important tax issue for those deciding to get a loan against their retirement account...

Consumers who tap their retirement accounts can take a loan from their 401(k) accounts worth up to $50,000, or 50 percent of the amount invested, whichever is less. There are no tax consequences for a loan in good standing. But if a borrower defaults, the loan is considered a withdrawal and subject to the same tax penalties.

Taking out a loan against your retirement account can have dire consequences.  Besides the tax issues above if you default, if you fail to contribute to your account for five years, you can expect nearly 20% less money available for retirement if you are 40 years old already.  That could easily spell financial disaster for you in the long run.