Money Management

Think twice before borrowing from your 401(k). 

You may have heard that taking out a loan from your 401(k) can be a great way to pay off debt. While this can be true under certain circumstances, it is important to understand the risks involved in taking out a 401(k) loan and why it may not be the best option for everyone. Before you make the decision to borrow from your 401(k), here are five reasons why you should think twice.

1. You lose out on potential earnings

When you take out a loan from your 401(k), you are essentially borrowing money from yourself and therefore missing out on potential earnings. When you borrow from your retirement savings, your withdrawal amount reduces the amount of money invested which could have grown with compound interest. Depending on how long you hold the loan and how much it’s worth, this could mean tens of thousands of dollars lost in potential earnings, hurting your chances of meeting your financial goals.

2. You risk owing more if you lose your job

When most people take out a loan from their 401(k), they don’t factor in what would happen if they were laid off or lost their job. If you lose your job while still paying back your 401(k) loan, you will likely owe taxes and/or penalties for not repaying it within 60 days of termination. In addition to owing taxes on the entire balance of the loan due to its premature repayment, there will also be penalties assessed by the IRS if you are under 59 ½ years old at time of termination.

3. You could end up taking more loans

Taking out a loan from your 401(k) may seem like an easy solution when paying off debt; however, it could easily become another form of debt itself if not managed properly. Once borrowers begin using their retirement funds for non-retirement purposes, it becomes a slippery slope. If you see a 401(k) as a way to pay credit card bills and personal loans, then it is easy to continue doing so without considering other options such as budgeting or being disciplined and following a financial plan.

4. You may not be able to contribute more money

Another issue with using a 401(k) loan for debt repayment is that with some plans, it limits your ability to contribute to your retirement savings during the life of the loan. For example, if you take out a $10,000 loan from your 401(k), then you cannot make any contributions to your retirement account until that $10,000 has been fully repaid. This means that you may not be able to take advantage of compound growth in your retirement savings account, reducing the amount of money you will have available during retirement.

5. You only have five years to pay it back

Finally, it is important to remember that a 401(k) loan is still debt and should be treated as such. It is an extra loan that you have to pay off. This is because when you take out a 401(k) loan, the money you borrow must be paid back within five years or less. If you are unable to pay it off in time, then you will have to face significant penalties, including a 10% early withdrawal penalty and income taxes on the unpaid balance. You need to budget for your monthly payments and develop a plan for paying off the loan.

There are many factors to consider before taking out a loan from your 401(k), such as potential loss of earnings and tax implications if you’re laid off or terminated while still paying back the loan. It is important to weigh all of these factors before making any decision regarding your retirement funds. Ultimately, when deciding whether to take out a loan from your 401(k), remember that this should be used as a last resort after exploring all other possible solutions.

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You may not need to lose sleep over an impending downturn after all. 

“Gear up for a recession before it’s too late.” Such were the warnings many financial experts were sounding constantly during the latter part of 2022.

Now to be fair, those sounding recession warnings weren’t doing so to cause needless panic. Rather, economists wanted — and still want — consumers to be prepared for a broad decline.

But today’s job market isn’t one that looks to be on the verge of collapse. And that’s something you might be able to take comfort in.

Job openings are still plentiful

In December, there were 11 million job openings, according to new data from the Bureau of Labor Statistics. The largest increases in job openings were in accommodation and food services, which added 409,000 open positions, retail trade, which added 134,000 positions, and construction, which added 82,000 positions.

Of course, a lack of job openings isn’t what will necessarily fuel a recession. Rather, it’s a decline in consumer confidence and spending.

The Federal Reserve has been aggressively raising interest rates since last year, and in doing so, it’s driven up the cost of borrowing. The concern is that consumers will balk at higher credit card interest rates and loan rates, and cut back on spending drastically to compensate. Once that happens, a recession could hit — and from there, job openings could decline as unemployment levels pick up.

But still, it’s hard to overlook the fact that right now, we’re dealing with a very healthy labor market. And so if you’ve been losing precious sleep at night over the idea of a recession, you may want to take a step back and remind yourself that we’re clearly not on the verge of an economic collapse.

It still pays to prepare for a downturn

A recession may not be imminent, but preparing for one is a good idea nonetheless. And one of the best ways to do so is to build yourself a solid emergency fund.

At a minimum, you should aim to have enough money in your savings account to cover three full months of essential living expenses — things like rent, food, healthcare costs, transportation, and utilities. This way, if you lose your job and it takes a while to find work again, you’ll have a means of covering your bills until you start collecting a paycheck.

It’s especially important to build yourself a solid emergency fund if you’re self-employed. Those who work for an employer are covered by unemployment insurance and are commonly entitled to jobless benefits that replace a portion of their paycheck when they’re out of work due to no fault of their own. But generally speaking, you can’t collect unemployment benefits if you’re self-employed, so if your workload dries up, you may need to rely on your savings for quite some time.

The fact that there were so many job openings in December is clearly a good thing. It doesn’t guarantee that a near-term recession won’t hit, but it’s certainly a great reason to worry a bit less about one.

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It could help you avoid a headache later on. 

Inflation surged in 2022, leaving many consumers struggling to make ends meet. Thankfully, employers are stepping up to help workers cope with inflation. According to data from Willis Towers Watson, salary increases in the U.S. are projected to hit 4.6% in 2023. And while that’s below the most recently reported rate of inflation, it’s a pretty decent bump in pay nonetheless.

But what if you’re getting a raise this year that amounts to much more than a 4.6% boost? Maybe you snagged a promotion after years of hard work. Or maybe you just got an advanced degree that rendered you eligible for a big bump in pay.

Either way, a higher salary is a good thing. It could mean getting to pump more money into your IRA account and getting to invest more in a brokerage account. It could also mean avoiding credit card debt for the first time in years.

But a giant pay raise could also impact your tax situation. And that’s an important thing to prepare for.

Your taxes might go up

The more money you make, the more taxes you’re likely to pay. That’s pretty simple. But what you may not realize is that earning a lot more money could bump you into a higher tax bracket, where you’re paying a higher rate of tax on your highest dollars of earnings. If that happens, and you don’t make any adjustments to the amount of tax you’re having withheld from your paychecks, then you could end up owing the IRS money next year — or owing more than usual.

That’s why if you’re getting a raise, a good bet is to set aside a portion of that extra money for tax purposes. That way, if you end up having to write the IRS a check in 2024, it won’t be a source of panic and stress. Instead, you’ll be able to simply dip into your savings account and come up with the money.

It’s not just a raise that could result in a higher tax bill

Earning more money at your job could easily result in a scenario where your tax burden goes up. But that might happen for other reasons, too.

This year, for example, savings accounts are paying more interest. So if you earn a lot of interest income, it could potentially propel you into a higher tax bracket or cause you to owe some money to the IRS next year. The same could easily hold true if you sell a lot of investments at a profit in your brokerage account.

That’s why it’s always a good idea to have extra money set aside for tax bill purposes — even if you typically end up getting a refund. The IRS will work with you if you can’t pay a tax bill in full, but in that scenario, you’ll accrue interest and penalties for being late. A better bet is to put yourself in a position where you can pay your tax bill in full by the time it comes due.

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The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Maurie Backman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Following this strategy could be all you need to do to end up rich. 

Building wealth is a goal everyone should have. This doesn’t necessarily mean you need to aim to be rich — but you want enough money to provide you with financial freedom, security, and the ability to retire without worry.

There are lots of different strategies for building wealth, some of which (like investing in cryptocurrency) can be much riskier than others. But the good news is, you don’t need to embrace complicated investments or spend endless hours managing your brokerage account if you want to become wealthy.

There’s a simple, boring wealth-building strategy that’s pretty much a sure thing and that just about anyone can adopt.

This wealth-building strategy is effortless and it’s all you need

Personal finance expert and YouTube personality Graham Stephan outlined the simple wealth-building approach that anyone can try out.

“The best way to create long term wealth is to Dollar Cost Average into an Index fund,” Stephan said. “It’s boring but you’ll beat almost everyone who tries something else.”

So, what exactly does this involve? Simple.

An index fund is an investment designed to track the performance of a financial index. For example, there are S&P 500 index funds. When you invest in one, your money is pooled with the funds of many other investors. The entire big pot of money is used to buy stock shares of the approximately 500 companies that make up the S&P 500 (a stock market index that tracks the performance of around 500 large U.S. companies).

If you buy an index fund, a little tiny bit of your money is invested in every company that is included in the index. If most of those companies perform well, your money will go up in value. With the S&P 500, there’s a long track record of the index doing very well. In fact, it has earned a 10% average annual return over the long term for decades.

Stephan specifically recommends dollar-cost averaging into an index fund. This is an investing strategy where you spend a set amount of money to buy shares of the index fund over time. For example, you could buy $1,000 worth of an S&P 500 index fund on the first of every month.

The benefit of dollar-cost averaging is that you don’t have to try to time the market, and you inevitably buy more shares at a lower price. If you always spend $1,000 and the price of the fund is $100 one month and $90 the next, obviously you buy more shares when you’re paying $90 each for them.

Why is this such an effective wealth-building strategy?

This strategy is extremely effective at helping you build wealth because index funds have a consistent track record over time. Plus, since you’re investing in so many companies, you’re minimizing your risk of any one company significantly underperforming or going bankrupt and sinking your portfolio. And by dollar-cost averaging, you’re buying regularly so you don’t have to worry about timing the market.

This approach is much safer and simpler than buying shares of individual stocks or other investments like crypto, and it’s one many people would benefit from embracing.

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Watch out for these potential pitfalls. 

Buy now, pay later (BNPL) payment options has been gaining popularity in recent years, growing by 1,000% since 2019. It’s a way for shoppers to purchase items online without having to pay for them upfront, essentially allowing them to spread out payments over time. But what many shoppers don’t realize is that BNPL can come with some hidden dangers — especially when it comes to their financial health. Here are the potential risks associated with BNPL and how consumers can protect themselves.

How does BNPL work?

BNPL allows shoppers to purchase an item or service upfront and then pay for it over time. This type of financing option can be extremely helpful for those who need a bit of extra time to save up but don’t want to miss out on a deal. Just as when you use a credit card, you are making a promise to pay back the money. The biggest pros are that there are typically no interest charges or late fees associated with these services. BNPL simplifies and streamlines the financing process.

In addition, there is no credit check required with BNPL since withdrawals come directly from your bank account. You can typically pay off your purchases in fixed installments over a set period of time that usually ranges from three to 12 months depending on the provider. But is BNPL too good to be true? Here are some hidden dangers and what you need to know before signing up.

The risk of overspending

One of the major risks associated with BNPL is that people tend to overspend on items they wouldn’t normally be able to afford if they had to pay upfront. This can lead to excessive debt that may be difficult for some people to manage. According to the Consumer Financial Protection Bureau (CFPB), close to a third of BNPL users have struggled to make the payments and to avoid defaulting on their plan, they had to skip paying an important bill. As a result, close to 1 in 4 (22%) Americans who have used BNPL have immediately regretted their decision, saying they wished they had not signed up for the plan.

The Consumer Financial Protection Bureau (CFPB) states that BNPL “is engineered to encourage consumers to purchase more and borrow more. As a result, borrowers can easily end up taking out several loans within a short time frame at multiple lenders or Buy Now, Pay Later debts may have effects on other debts.”

Potential fees, interest, and rewards

While BNPL plans typically don’t charge interest, more providers are starting to, along with charging late fees. If shoppers are unable to complete their BNPL payment plan, they can be charged additional fees. Depending on the provider, these fees can add up quickly and cause even more financial strain than expected. This can lead shoppers further into debt if they’re not careful.

BNPL plans may advertise that they charge no fees, but only half of the BNPL users surveyed by the CFPB stated that their plan was completely free. Of those surveyed, 14% said they paid a flat fee; 7% paid late fees; 8% paid interest of 30% APR or less; and 4% paid an APR higher than 30%. The remainder did not know how much they paid in interest.

It is important for consumers to read through their BNPL agreements carefully before signing up. They should understand exactly what types of fees they may be charged if they miss a payment or default on the agreement altogether. In addition, while your credit isn’t checked when applying for BNPL, your credit score can be impacted if you don’t make a payment on time. With BNPL you also don’t get points, miles, or cash back like you might with a rewards credit card.

What consumers can do to protect themselves

Fortunately, there are some steps shoppers can take in order to protect themselves from the potential dangers of BNPL:

Make sure you understand the interest rate or fees that will be applied if you miss a payment.Don’t purchase items you wouldn’t normally buy just because they’re offered as part of a BNPL program.Always read the terms and conditions carefully before committing.Set reminders for yourself about upcoming payments or due dates.Consider other forms of financing such as credit cards (which offer greater protections) instead of relying solely on BNPL programs.If necessary, seek professional help from an experienced debt counselor who can guide you through repayment options.

Buy now, pay later offers a convenient way for consumers to purchase items without busting their budget, but it also comes with certain risks that need to be taken into consideration. By understanding those risks and taking necessary precautions, shoppers can enjoy the convenience of BNPL while avoiding its potential dangers. Understanding these concepts will ensure shoppers are comfortable and prepared before committing themselves financially.

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Feeling house poor doesn’t have to be a permanent condition. 

If your housing expenses — including mortgage payment, homeowners insurance, utilities, maintenance, and property taxes — leave you with little left over each month, you may be called “house poor.”

The first thing to know is that there’s no shame in your situation. Anyone can become house poor, no matter how much money they earn. It’s all about the portion of your income dedicated to keeping you in that house.

For some homeowners, becoming house poor comes as a shock. From the time they first met with a mortgage lender, they were confident they earned enough money to keep them comfortable. And then something happened. It could have been a sudden illness, job loss, divorce, or other change in circumstances.

No matter the cause, if you’re feeling house poor now, here are four steps you can take to help alleviate that feeling.

1. Reduce your other bills

The good news is that reducing your monthly bills is possible without sacrificing your standard of living. If you’re looking for more cash at the end of each month to save, invest, or pursue a particular interest, it’s possible to free up some of what you’re currently spending. Here are some of the ways to make it happen:

Switch insurance carriers

Let’s say you switch your auto insurance from one company to another. Studies show that consumers who switch save around 19%. You could save even more if you have a better driving record today than when you were first quoted insurance rates. Remember to take advantage of every insurance discount you’re eligible for.

While you’re at it, collect new quotes for homeowners insurance. You may be overpaying there, too.

Cook at home more

According to Bureau of Labor Statistics data, the average American household spends around $3,500 per year eating out. That’s nearly $300 per month. We’re not suggesting that you never eat out. Simply cut back on frequency. This may mean packing your lunch before work or putting something in the crockpot to enjoy after your child’s ballgame.

Imagine if you were to cut back by half. That frees up an extra $150 per month.

Make a shopping list and stick with it

Before you go grocery shopping, create a list based on the meals you plan to prepare and the snacks you want around the house. And then stick like glue to that list. So much of what ends up in our carts are impulse buys. You can cut costs by becoming a stickler for a list.

Reduce energy usage

One of the simplest ways to begin saving money today is to trim your energy budget. Here are some of the fastest ways to make that happen:

Take shorter showersCheck seals on doors and windows. Seal any leaks you find.Avoid “vampire energy” by unplugging appliances, TVs, computers, and other electronics when not in use. It’s silly to pay for energy you’re not even using.Water the flowers, shower, do laundry, and run the dishwasher in the evening when the rates are lower.Wash clothes in cold or warm water. The cooler the water, the less energy it takes to heat it.Turn down the heat. If you typically leave your thermostat set at 72 degrees, turning it down by even one degree can help.Swap incandescent light bulbs for LEDs.

2. Collect rent on extra space

We Americans collect so much stuff, and many of us don’t have the space to store it. If you have an empty attic, extra room, or space in your basement or garage, consider listing it for rent on a site like Neighbor. When people in your area need someplace to keep their stuff, they can rent from you rather than deal with a rental unit. You set the price, and the company provides insurance coverage.

3. Buy used

Most things that can be purchased new can also be purchased used. When it’s time for a new summer wardrobe, hit a consignment shop. Check out a used sporting goods store when the kids want a new skateboard. Until you’re back on solid financial footing, buying used is another way to fill the gap.

4. Create a realistic budget

Going through life without a monthly budget is like taking a trip without GPS. Many of us have underestimated bills, been frustrated when things didn’t work out, and tossed the budget out the window. The trick to building a budget is to make sure it’s realistic.

Another advantage of a budget is how clearly it shows where you’re overspending and where you can cut back without discomfort.

Being house poor is not the same thing as being unable to pay your mortgage. If you cannot make a mortgage payment, contact your mortgage company immediately, as they’re the best source for options.

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We’re firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers.
The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.Dana George has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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