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Question: Should we roll over our 401K to an IRA to use this asset to pay for remodeling our home?
— Gayle in Texas
Gayle, it is amazing how such a simple question can have such big consequences. There are some basic issues worth considering before you launch into this obvious plan of action.
For example, your 401(k) is most likely protected from your creditors right now. But if you roll it into an IRA with commingled money, you can risk losing it all if you were unexpectedly sued.
And these suits are totally unpredictable. All it takes is a bad accident you could be blamed for — and poof, there potentially goes your retirement. I’d make sure you consult with an attorney who is licensed in your state to best understand how any rollover might expose you to a loss in this situation.
Then there’s this: If this is a company 401(k), you will lose the ability to access the funds at an earlier age without a tax penalty.
What I am assuming from your question is you want to borrow against your IRA or use some money from this exchange to help fund your remodel. It’s your money, and you can do whatever you want with it, include lose as much as you want.
My primary issue with the access of retirement funds like a 401(k) or IRA is the loss of return. People get distracted and think they are borrowing their own money at a low-interest rate like 5 percent. But what most miss is that a 5 percent loan is really costing you 20 percent in good return years. And right now, we’re in a span of good return years.
During the time that the money you’ve borrowed is out of your retirement account, it is now growing with the rest of your funds and bringing down the entire value of what your retirement funds would have been.
So borrowed remodel funds can now wind up costing you a lot just when you need it most. For example, using this online retirement fund loan calculator from Bankrate.
You can see that a $30,000 loan from your retirement funds — 401(k) or IRA — will cost you $78,091 in repayment and lost growth on the funds while they were borrowed. If something comes up and you can’t repay it in time, then the lost value can be as much as $1,138,148.
Yes, that’s more than $1 million.
I guess you could label me as a financial libertarian because I believe people need the facts and they are entitled to make their own wrong choices. Ultimately, the question is not if you can do this, but if you should do it. Only you can make that choice. Good luck.
Email your question to email@example.com and Howard Dvorkin will review it. Dvorkin is a CPA, chairman of Debt.com, and author of two personal finance books, Credit Hell: How to Dig Yourself Out of Debt and Power Up: Taking Charge of Your Financial Destiny.
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