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Originally published Saturday, January 11, 2014 at 8:03 PM

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Don’t borrow from 401(k) for remodeling | Scott Burns

Borrowing from a 401(k) plan almost never makes sense. It’s an emergency step, not something for daily life.


Syndicated columnist

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...As a practical matter, the interest rate on home-equity credit lines is currently... MORE

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Investing

Q: My wife and I are going to do an addition to our house. We’re both 45 years old and have plenty of equity to support $400,000 of borrowing.

I was thinking of borrowing from our 401(k) plans. My wife is concerned that we will lose the tax deduction and, if something happens, we have no retirement. What are your thoughts?

A: Listen to your wife; she’s clearly a wise woman. Borrowing from a 401(k) plan almost never makes sense. It’s an emergency step, not something for daily life.

As a practical matter, the interest rate on home-equity credit lines is currently only a bit higher than the inflation rate. In addition, the interest is tax-deductible. It is possible that the net, after-tax cost of borrowing will be about the same as the inflation rate. In effect, the cost of borrowing will be zip. Keep your powder dry in your 401(k) accounts, leaving flexibility for a real emergency, should one arise.

Q: I am continually concerned that you and others keep telling those who are eligible for Social Security to delay taking the benefits.

Here is how I figure it. I take my Social Security benefit at $1,230 a month. At the end of the year I have received $14,760 in income. I continue to get $1,230 a month (adjusted for inflation).

My friend who could get the same benefit delays taking it. At the end of the year, he has zero. He now gets 8 percent more each month or about $1,328. That’s nice, but at the end of year two I have collected a total of $29,520 and he has collected $15,936.

The “cross-over” point for total benefits — where he, in total, receives more than me — does not occur for nearly 13 years!

This does not take into account that I might have invested all or part of the first year’s benefit. Or that I might not live 13 years. Or that Social Security as a program may not exist by then. Bottom line: I say take the benefit and use it while you can. Please let me know if you see a fallacy in this plan.

A: I understand your concern about the break-even time (it’s actually 12.5 years), but the answer is a matter of probabilities, not how we feel about whether it will be a good deal or not.

If you lump together the entire population, we collectively have a life expectancy of 17.8 years at age 66. This means 50 percent of the group between age 66 and 67 will live at least another 17.8 years. Yet the break-even in real purchasing power is 12 years. That makes deferral a pretty good bet.

Another factor is how much more money may mean to you in the future compared to what it will mean to you today. Here we find that most people want to eat dessert first.

They’ll say: “I’d rather have more money this year than a bit more money for the rest of my life. I know I can enjoy spending the money today. I don’t know if I’ll have the capacity to enjoy spending the money 12 years from now when I am 78.”

That’s a question you’ll have to answer for yourself.

Questions: scott@scottburns.com

Copyright 2014,

Universal Press Syndicate



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