Should You Borrow from Your 401(k)?

You may be tempted to take a loan from your employer sponsored retirement account.  Payments will be deducted automatically from your pay check and you have five years to repay (longer if the proceeds will be used for a down payment on a first-time home).  The interest rate may be low (often, one or two percent above the prime rate) and the paperwork is minimal.  Not so fast.... you need to understand the ramifications of what you are about to do.

My blog posting of 12/29/11, titled “How is Your 401(k) Doing?” advised against borrowing from your 401(k) even if your plan makes loans easy to get.  The posting also advised treating your 401(k) as one of your prized possessions.  Your 401(k) plan may be the deciding factor in determining when you can retire and how comfortable your retirement will be.  It is not wise to borrow from your future to pay for current obligations.

Some of the downsides of borrowing from your retirement account are:

·       The outstanding loan must be repaid within 60 days should you or your employer terminate your employment.  If not repaid the loan will be treated as a taxable distribution and subject to a 10 percent tax penalty if you are under age 59 ½.

·       You will need to have other funds to pay the taxes due which will be payable by April 15 of the year following the year of distribution.  Using retirement funds to pay the taxes will increase the 10 percent penalty.

·       There are lost opportunity costs while the loan is in force as you may be prohibited from making contributions to the plan during this time.  Your interest payments on the loan will be credited to your account, but that may be less than the investment returns you would have otherwise received.

·       Payments on the loan will be deducted from your pay each month, and you generally cannot stop this even if you should incur a financial hardship.

I advise people to take 401(k) loans only as a last resort.  A 401(k) should not be used as an emergency fund or paying for a luxury item or a vacation, nor should it be used if funds are available from other sources.  If you have a true emergency and there are no other funds available, you may have no other choice.  Should this be the case, pay down the 401(k) loan as soon as possible rather than extending for five years.  Five years is a long time, and you may change jobs or be laid off and faced with having to pay off the loan, or have to pay taxes and a 10 percent penalty on the unpaid amount.

Remember you can borrow for many reasons, but your retirement is not one of them.

Bill Tarlo's 10 Rules for Smart Investing

These rules for investing apply if you are a do-it-yourself (DIY) investor or if you use the services of a financial advisor.   Remember that there is a difference between investing and saving.  Investing is usually related to a longer term goal such as retirement whereas saving is typically for a shorter term goal such as a vacation.  The terms are often interchanged, but not necessarily synonymous.  The term “investing” is somewhat nebulous as it does not state how funds will be allocated and what investment vehicles may be used.  

Here are my 10 rules for smart investing:

1. Investing should be done as part of a financial plan with pre-defined goals.  Examples of these would be retirement, paying for children’s education and purchasing a first home where both the amount of money required and the time to acquire it can be reasonably estimated.

2.     Investing should take into account the investor’s risk tolerance.  All investments pose different degrees of risk, and the greater the risk the greater the potential reward and potential loss. 

3.     Never invest in anything you don’t understand or sounds too good to be true.  People who were burned by the Bernie Madoff Ponzi scheme did not follow this rule.

4.     Invest in low cost mutual funds and exchange traded funds (ETFs).  Expenses do matter and over a 25 or 30 year period can mean the difference between a secure retirement and one not so secure.

5.     Avoid investing in individual stocks unless you know the company well and are prepared to do research and follow the company regularly.  No one can know a company as well as insiders (e.g., management, board of directors and counsel).  If you only have a portfolio of individual stocks you are unlikely to have a diversified portfolio.

6.     Use the services of an independent fee-based financial advisor if you are not comfortable as a DIY.  Do not use someone who is selling proprietary products and receives a commission.  Use an independent fee-based professional.

7.     Do not chase return; past performance is no guarantee of future return.  It is more important to avoid huge losses when the market is tanking than to achieve the highest returns when the market is on a hot streak.  You should strive for a portfolio for all seasons.

8.     Invest for the long term and review your investments periodically (quarterly or not less than semi-annually).

9.     Do not ignore income taxes when making investment decisions.  The tax code is complex and small mistakes can cost thousands of dollars.

10.  Get a second opinion if you have any doubts about your financial advisor.   Warning signs are:  not returning phone calls promptly, pushing specific investment products, inconsistent advice, and poor performance over an extended period.

Following these rules will not guarantee financial success but they will increase the probability of reaching your financial goals.

Is an SBA Loan Right for Your Business?

The U.S. Small Business Administration (SBA) provides a number of financial assistance programs for small businesses.  This posting provides information about the SBA guaranteed loan programs.  The SBA does not lend money to small businesses, but guarantees loans made by SBA partners, primarily lending institutions (banks, community development organizations, etc.).  The SBA’s guarantee is the inducement for lenders to make loans that they otherwise would not make.  The SBA guarantees that the loans will be repaid thus eliminating the risk to lenders.  The SBA sets guidelines and requirements for the loans to fulfill the SBA guaranty.  SBA loans will not be made to businesses if the borrower has access to other financing on reasonable terms.  SBA loans can provide financing to qualifying fledgling small businesses and start-ups when they are unable to secure conventional financing.

There are several types of SBA loans available to small businesses:

• General small business loans 7(a).  This is the SBA’s most common loan program and can be used to purchase equipment, renovate your facility, access working capital and other special needs.
• Microloan program.  Can be used to obtain a revolving line of credit, or term loan for short-term working capital and other purposes.
• Real estate and equipment loans CDC/504.  This type of loan can be used to finance major fixed assets such as equipment or real estate with terms of up to 20 years.

As an incentive to help make financing more available to small businesses the SBA is waiving its guaranty fee on loans of $150,000 or less through September, 2014.  This can result in a savings of more than $2,500 on a $150,000 loan.  Also, effective January 1, 2014 the SBA launched a program for small business owners who are veterans, the SBA Veterans’ Advantage, which waives fees on loans up to $350,000.  This program is also available through September, 2014.

The National Small Business Resource Guide which can be accessed from the SBA website, www.sba.gov, can be helpful in deciding whether to seek an SBA guaranteed loan for your business.

Please see my blog posting dated February 11, 2014 for steps to take before talking to a business banker to see if you qualify for an SBA guarantee.

Now May be a Good Time for a Business Loan

Thinking about expanding your business, purchasing new equipment, making leasehold improvements or maybe you just need more working capital.  Now may be a good time to apply for a business loan.  Interest rates continue to be low, banks have money to lend and the Small Business Administration is waiving the guaranty fee on loans of $150,000 or less through September of this year. 

This posting provides general information to help the business owner prepare to apply for a business loan whether conventional or SBA.

Here are steps to take prior to talking with a business banker:

1.     Document the amount of the loan you need, why you need it, and how you will use the proceeds.  Have specific quotes in hand if you are thinking about purchasing equipment. Describe what the equipment will do for your business (expansion, increase productivity, lower costs, etc.).  Provide a clear explanation of what the loan will do for your business whatever the reason

2.     Demonstrate your ability to repay.  You will need to show the lender how you will repay the loan and the sources available for repayment.  A pro forma cash flow statement showing the amount of cash your business will generate over the term of the loan will be helpful.  Other sources of income if any should be documented.  Know the value of your business property that may be pledged for collateral if applicable.  A personal guaranty may be required.  Personal guaranties should be avoided wherever possible; however, if there is insufficient collateral this may be unavoidable. 

3.     Submit a business plan with your loan application.  This is not always a requirement, but a well prepared business plan can go a long way in persuading a lender to make the loan.  The business plan will describe your business, the industry and market you operate in, and your management team if applicable.  Financial statement projections should be included (balance sheet, P&L statement and cash flow).  You can get more information on preparing a business plan by going to the SBA web site, www.sba.gov.

4.     Your lender will require documentation with your loan application.  Be prepared to submit copies of financial statements, tax returns, and lease agreements.   Lenders may request copies of employment contracts with key employees and contracts with major customers that could significantly impact the business.  The amount and type of loan will dictate the documents required.

It is also a good idea to check your credit history to correct any errors prior to applying for the loan.  Also, let the lender know if you or your business is involved in any litigation and the status of the litigation.

My next posting will cover the types of SBA loans available.  SBA loans are government guaranteed, and in some cases these may be the only type of loan available to your business.  The SBA is helping to make financing more accessible to small businesses.