Borrowing From Your 401(k) Could Be Hazardous To Your Wealth

Borrowing from your 401(k) plan should be your last resort, not your first. Ideally, you will never touch your retirement funds, allowing them to grow continuously until you retire. But we don't live in an ideal world! With home prices falling and lenders tightening credit, an increasing number of Americans are borrowing money from their 401(k) retirement plans. In the long run, the disadvantages clearly outweigh the advantages.

Taking loans against a 401(k) plan is allowed by law, but an employer is not required by law to allow it. If offered, an employer must adhere to some very strict and detailed guidelines on making and administering a loan. The statutes governing plan loans place no restrictions on what the need or use will be for loans, but an employer can restrict the reasons for loans. Some plans charge fees when you borrow from your 401(k). Plans can charge a one-time fee, a maintenance fee, or a combination or the two.

There are several advantages to a 401(k) loan over other types of loans. A plan participant can borrow up to half of their vested balance, but no more than $50,000. There is no credit check and no qualifying, although you may need a spouse to sign a consent form. You may receive the loan in a matter of days and have up to five years to pay the money back, except when the funds are borrowed for the purchase of a residence, in which case you may have up to 15 years.

You pay interest on the amount borrowed - often the "prime rate" plus one or two percentage points. Interest proceeds then become part of the borrower's plan balance. There is a popular misconception that paying back a plan loan is like paying yourself. While it is true that you are paying yourself interest, when you borrow money from yourself you are simply replacing the interest you would already be receiving from someone else with interest payments from yourself. Paying yourself interest is sound advice when it is an alternative to paying someone else interest, but not as an alternative to receiving interest from someone else.

You repay the loan through automatic payroll deduction with after-tax dollars, plus you lose the compounded interest that you would have received if you had left the money alone because the amount that you borrow is subtracted from the principal balance. You have no flexibility in changing the payment terms of your loan. You also get taxed twice - once when repaying the loan with after-tax dollars, and a second time when the money is withdrawn at retirement.

So, let's say your monthly payment is $300 and you're in a 28% Federal tax bracket. You'll have to make $416 in gross earnings to have enough left after taxes to make the $300 payment. Interest paid on the 401(k) loan is not tax-deductible even if you borrowed the money to purchase a residence.

If you default on a 401(k) loan, you will receive a Form 1099 from the plan because the government considers the defaulted balance a taxable withdrawal. You will be charged Federal and State taxes on the outstanding balance plus a 10% penalty if you are under 59 1/2 years of age.

The biggest disadvantage is the following: If you leave your job, even if it is not your choice to leave, the 401(k) loan comes due and typically must be repaid within 30 to 90 days. If you cannot pay the loan in full you will be charged Federal and State taxes on the outstanding balance plus a 10% penalty if you are under 59 1/2 years of age.

Another disadvantage is the temptation to reduce or eliminate the amount you are contributing to the plan because you now have a loan payment, which will reduce your long term retirement account balance. If you stop contributing while you have an outstanding 401(k) loan, you will also miss out on the company match, provided your company offers a match.

Lastly, when you apply for a mortgage, current lending guidelines state that any 401(k)loan payments will be counted as a debt and included in your debt ratios and any outstanding loans will be subtracted from the your vested 401(k) account value for reserve purposes.

The bottom-line is if you are considering borrowing from your 401(k) make sure you understand the consequences, both good and bad.

Are You Paying Too Much In Property Taxes?

Did you know that over the last eight years, property taxes have actually outpaced even inflation? Those rising taxes – combined with the recent plateau in house values in some areas – means you may be paying more than your fair share.

If you purchased your house or completed construction on your house since 2004, it is possible and very likely that you are paying too much for your property taxes. Some people who purchased in 2003 may even be affected. The current decline in house values is affecting everyone but some areas are affected more than others.

Under Proposition 13, property taxes can be increased annually by no more than 2% to account for increases in your property’s value due to inflation. Shortly after Proposition 13 was passed, Proposition 8 was passed, which allows a temporary reduction in property tax assessments. Under Proposition 8, a temporary reduction in assessed value can be made when the market value falls below the current assessed value. This is an important distinction because the assessed value may not be the same as the market value. Many counties use a formula which uses a percentage of market value to determine assessed value. Your property’s assessed value is shown in the upper right hand corner of your current tax bill as “Net Taxable Value.”

In practical terms, and with the history of real estate appreciation, most assessed values in San Diego County are well below even current market value. Realistically, this will only affect those property owners who purchased their property at the height of the current real estate market.

If you believe your property’s market value has fallen below its current assessed value you should file an Application for Review of Assessment with the Assessor’s Office as soon possible but no later than May 30, 2008. Click here for easy access to the required forms. Submitting an appeal is generally a fairly simple process, but make sure to take the time to fill out all forms in advance and be prepared with your documentation if there is an in-person hearing that needs to take place. My understanding is that due to the high volume of requests the Assessor’s Office will be notifying property owners in early July of the results of their request.

You can mail or drop off the completed forms to the San Diego County Tax Assessor at 1600 Pacific Highway, Room 103, San Diego, CA, 92101.

A word of caution: If you appeal for a lowered assessment and it is determined by the board that the current market value of your property is actually greater than your current assessed value they can increase your property taxes. The bottom-line here is to compare your current market value to the current assessed value on your tax bill to determine if you are even a candidate before you take any action.

Your appeal must be based on the market value of your property as of January 1 of the year in which you are filing. For example, if you file your appeal in 2008, your appeal must be based on the market value of your property as of January 1, 2008. An application must be filed for each year you disagree with the assessor’s value, even if you have a decline in value appeal pending for a prior year.

If you need current comparable sales to your house you are welcome to send me an e-mail to Shawn@YourFavoriteLender.com with the address in question and I will be happy to forward them to you. You may need to submit proof of the decline in value to the assessor along with your request.

If your appeal is successful, the new assessed value will be used to determine your property taxes for the year appealed. The new assessed value of your property, however, does not automatically become the value for the following year. The assessor is required to review your property’s value annually once a decline in value has been determined. He or she will compare your property’s market value with its base year value plus adjustments for inflation. The base year value is the value of your property at the time of the change in ownership from the seller to you or at the completion of construction. The assessor is required to assess your property at the lower of those two values.

According to the National Taxpayers Union, about 33% of property tax appeals succeed! Taking the time to review the accuracy of your tax bill could easily save hundreds of dollars per year, adding up to thousands of dollars during the time that you own your house. Please feel free to contact me at (619)574-6545 for more information on this money-saving tip.

There are numerous private businesses and individuals mailing solicitations to property owners offering their assistance in this process for a fee ranging from $175 to $300. While you are at liberty to use a company if you wish, you can apply for this reduction yourself at no cost by simply filing the application.