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401k withdrawal or loan
Old 07-24-2007, 05:06 PM   #1
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401k withdrawal or loan

I retired a year ago at age 55. I now need some cash and was trying to figure if it would be better to take a withdrawal or a loan. I understand that "the rule of 55 means I won't have a penalty for withdrawal. I cannot put money back into the 401k if I withdraw it. If I borrow I can but it back by repaying the loan, so the 20% tax wouldn't be taken. I have always heard it isn't a good idea to take a loan from your 401k, but how about now that I am retired? Which is the best to do? Or is there something better yet?
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Old 07-24-2007, 05:16 PM   #2
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Originally Posted by glinka View Post
I retired a year ago at age 55. I now need some cash and was trying to figure if it would be better to take a withdrawal or a loan. I understand that "the rule of 55 means I won't have a penalty for withdrawal. I cannot put money back into the 401k if I withdraw it. If I borrow I can but it back by repaying the loan, so the 20% tax wouldn't be taken. I have always heard it isn't a good idea to take a loan from your 401k, but how about now that I am retired? Which is the best to do? Or is there something better yet?
Are you sure you can take a loan from a 401k when no longer employed?
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Old 07-24-2007, 07:10 PM   #3
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A loan against your 401k is a very bad idea indeed. You contributed pre-tax funds to your 401k plan. When you take out a loan using your 401k as collateral, you have to repay the loan with after tax money. In other words, you have to pay taxes on the money that you earn which you then use to repay the loan. Therefore, after you repay the loan, your 401 now has AFTER TAX MONEY, whereas before the loan it had pretax money. Then, when you eventually withdraw the money, you pay taxes on that money AGAIN. If you didn't take out the loan, you would have paid taxes on that money only once.

If you borrow $10,000 from your 401k plan, and assuming you are in the 25% tax bracket, you have to earn $13,333 to repay the $10,000. Then, when you later withdraw the funds from the 401 plan, (assuming you are in the same tax bracket) you have to pay $2,500 in taxes, which leaves you with $7,500. So, to summarize, you earned $13,333, and you get to keep $7,500. That's a tax rate of 43%.

If you do not borrow from your 401k plan, you have to earn $10,000 to contribute $10,000 (contributions are tax deferred). Then, when you later withdraw the funds, you pay $2,500 in taxes, which leaves you with $7,500. That's a tax rate of 25%.

That $10,000 loan costs you $3,333. A $50,000 loan would cost you $16,665 in taxes. (Not counting the interest charges)
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Old 07-24-2007, 09:44 PM   #4
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Are you sure you can take a loan from a 401k when no longer employed?
Ditto. Can you? I understand that it can not be done.
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Loan
Old 07-24-2007, 10:08 PM   #5
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Loan

Fidelity states I can take loan at 8.25%. From what I see now this would be a bad idea. I am 56 and was concerned about hitting the 401k this soon. I would wind up taking about 4% out. This , I guess wouldn't be out of line but it still seems early to me.
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Old 07-24-2007, 10:28 PM   #6
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That's strange. Fidelity manages my 401k account too and I am quite certain loan will not be available to me once umemployed. In fact, once unemployed current outstanding loans have to be paid back within 60 days, or the loan would be considered a withdrawal with penalty.

Maybe it's different for people who become unemployed at age 55.
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Old 07-25-2007, 10:25 AM   #7
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Whether you can take out a loan might depend on the plan. I know that the 401k plan I had at work allowed retirees and any former employees still in the plan to borrow from the plan. I learned this when a former employee wanted to take out a big loan to buy a home.

I thought it quit strange because when an employee quits their loans under the plan come due immediately. Nevertheless, the employee could pay the loan off and then take a new loan provided it was for a permissible purpose under our plan.



That said, because you left the employer when you were 55 or older, if you need the money to live on just take the distribution.
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Old 07-25-2007, 11:01 AM   #8
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Op, If you are retired what other income do you have that you figure that if you will tap the money that you will have to pay 20% in taxes...are you figuring in at least your standard deduction and personal exemption for the year? Even a HELOC at current rates would be a better loan deal if you needed short term money...
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