Using Credit to Fund Your 401(k)

The credit union where I bank sent a Winter 2008 newsletter with their statement this month. It includes an article titled “Some 401K Tips.. What Do I Do Now?”, which breaks out different ages (20s, 30s, … up to 60s) and advises how each group should respond to the loss in equity across our nation.

Age: 40s

Only 10% of 401(k) participants in their 40s are saving the full amount allowed under the pretax IRS or 401(K) plan ceiing. “You can get car loans, you can get college loans, but you can’t get retirement loans,” says Fidelity’s Mike Doshier. So don’t dip into your 401(k) for expenses.

You can find the same quote in the Dec 17th, 2008 entry of the Society for Human Resource Management web site. I think Mr. Doshier, a vice president in Fidelity’s retirement services business, is saying to take out a loan so you can invest the cash you save into a 401(k).

Eee gads! And you wonder why our nation is in a financial crisis. How is his suggestion helpful? And why is my normally conservative credit union publishing such muck? He’s advocating taking out a notoriously expensive short-term consumer loan in order to fund a retirement account. Why borrow money at 9% in order to get a return of less than 9%? You’re accepting a for-sure heavy debt payment schedule for a maybe return on money that is at a lower rate! Financial Institutions loan you money to make money. You can’t invest borrowed money back with financial institutions to make more money than they’re making off from you.

Mr. Doshier’s suggestion is like the Escher painting that looks as if you’re climbing, but you’re going nowhere. If you don’t believe me, please contact me because I can give you better terms than other financial institutions, with a whole lot less paperwork! I'll pay you 7% if you take out a 9% loan with me. We can save all the paperwork and transaction costs if you just send me the 2% in the form of a check each month.

Climbing Up Going Nowhere

Maybe Mr. Doshier has some complicated tax advantage thing in mind. Perhaps he advises to borrow money, and recover 25% of the interest by not paying it to the government as tax (but even this is limited to housing), then use the borrowed money to invest in something that may give a return.

If there were no transaction costs, you’d need to find an investment that was making 75% of your credit rate to break even with this scheme. For example, take out a car loan at 8%, you need an investment at 6% to make back the money you'll loose in interest. And that's true only if the IRS allows the car interest as a business expense.

Created by admin. Last Modification: Wednesday 11 of March, 2009 12:23:47 CDT by brian.