Borrowing against a 401(k) is dumb
I have 16 people on staff, and I have a 401(k) plan in place. Recently, one of my employees asked if she could borrow against her 401(k) in order to buy another car. What do you think my response should be?
As an employer, you have the option of making this available. I don't make it available at my company, however, because I think it's stupid. As a leader, I want to help my team, not do things that can harm them.
Borrowing against a 401(k) is dumb for any reason. On a personal finance basis, the reason it's dumb is that when she leaves the company-and she will leave the company someday, whether she takes another job, gets fired, or passes away-the loan is called due in full. If you don't pay it within 60 days, the IRS considers it an early withdrawal, and they'll hit you with all kinds of taxes and penalties.
The second reason it's a dumb idea is that the stock market has been performing beautifully lately. Unplugging your 401(k) investments and only paying yourself back an interest of five or six percent when you could've been making 12 percent or more is a really bad plan.
If I were in your shoes, I'd talk to this team member and offer to put them through some financial counseling. That way, they could learn to take control of their finances, start living on a budget, and pay cash for a car. My point is that the real problem here isn't the 401(k) or borrowing the money. It's that the overall financial health of the team member is not good. If she was in good shape with her money, she wouldn't want to borrow money for a car.
Whether it's one of our products or another one out there on the market, offering something to help her take control of her money would go a long way toward getting her financially healthy. Then you don't sound like a mean, old ogre for saying, "No, we don't offer the option of borrowing on our 401(k), because that's stupid." Even if that is technically the correct answer.
Dave Ramsey is America's trusted voice on money and business. He's authored four New York Times best-selling books: Financial Peace, More Than Enough, The Total Money Makeover and EntreLeadership. The Dave Ramsey Show is heard by more than 6 million listeners each week on more than 500 radio stations. Follow Dave on Twitter at @DaveRamsey and on the web at daveramsey.com.