by Nancy Anderson
Vacations are good for you.
You get a break to spend time with friends and family. You can disconnect from work and recharge your batteries. You get to spend the money you work so hard for on something that will bring you fulfillment and happiness.
Vacations are great, but taking out a loan to pay for them isn’t.
According to Catherine Golladay, vice president of participant services at Charles Schwab, “At Schwab Retirement Plan Services, we often see instances of participants taking 401(k) loans increase during the summer months. Moreover, data shows that one of the reasons people have taken a loan from their 401(k) is to pay for a vacation.”
To put this mistake in perspective, consider this: A vacation is one or two weeks long, and a 401(k) loan is generally set up to be paid back over five years. This strategy sounds like a short-term vacation turning into a long-term debt.
“These people have the wrong idea,” Golladay says. “Even though a 401(k) loan can seem like a quick cash fix, it carries long-term consequences, and therefore should only be used as a last resort to address a true and critical need.”
Loans are fairly common among 401(k) participants. According to the Employee Benefit Research Institute, at the end of 2013, 21% of participants who were eligible for 401(k) loans had unpaid loans from their 401(k) accounts.
However, there are definite downsides to 401(k) loans. Golladay explains three of them:
“For one, while a traditional 401(k) is funded with pretax dollars, a 401(k) loan is repaid with after-tax dollars,” she says. “Second, if you leave your job and are unable to repay the loan in full, the outstanding balance is treated like a withdrawal, triggering a tax bill and likely a 10% penalty on top of the tax.”
“One of the biggest advantages a 401(k) plan offers is the ability for your investments to potentially compound and grow over time,” she adds. “If you take funds out of it prematurely, you diminish the benefit of compounding. Don’t punish your future self by borrowing against your retirement.”
Here are a few alternatives:
Get ahead of your vacation rather than behind it. Instead of borrowing to pay for a trip or putting it on a credit card, consider a “staycation” this year. Then, start a dedicated savings account for future trips. Plan your vacation based on the amount you are able to save.
Make memories, but not at the expense of financial security. Take your dream vacation every other year, every third year, or as often as your funds allow without having to sacrifice putting money toward your financial goals.
Earn extra funds as motivation. Whether you earmark part of your annual bonus to fund vacations or start an Etsy business on the side, have your vacation be your reward for extra effort. You can enjoy it fully, since you know you aren’t going into debt to do it.
For example, my husband is retired, but works as a substitute teacher during the school year. We set aside those extra funds for us to travel and to bring family to us in Park City, Utah. Since we have adult children spread out from Pasadena, California to Virginia Beach, this works out great!
Enjoy the summer and create memories that last a lifetime. Just don’t go into debt to do it.