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Pros & Cons of Loan from Tax-Deferrred Account for Rehab?
Old 11-24-2012, 12:25 PM   #1
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Pros & Cons of Loan from Tax-Deferrred Account for Rehab?

I've just bought a house for a post retirement residence. I'd like to tap the wisdom of E-R about an idea that just occurred to me. The house needs several thousand dollars' worth of rehab work, more than the amount of cash I have left from the sale. It would be much more convenient to get the majority of the work done before I actually move in, but the only way to do that is probably to take the money out of my retirement account(s). I don't plan to retire from my job until after I have reconstructive surgery, which is scheduled for the end of next April.

As yet, I haven't decided on a move-in date, partly because of this financial pinch, and partly because I will probably be pretty helpless for a couple of weeks after reconstructive surgery. Up until this morning I had only thought of two alternatives: move in earlier and put up with the inconvenience of living in a house under construction, or delay move-in until late next spring, after I retire. It occurred to me today that I could take a loan from my deferred compensation account, have the work done early next year before I retire, and then move in. I need to check with the plan representative, but I believe if such a loan is not paid back by the time I retire, it counts as a distribution, and would be taxed as ordinary income. I don't believe it would be subject to an early withdrawal penalty, because the plan allows withdrawals if you are over 55 at the time of retirement, which I will be. If I wait until after I retire to take the money out, it would also be taxed as ordinary income.

Your thoughts?
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Old 11-24-2012, 12:39 PM   #2
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Sounds like it would be the same bad idea that a 401k loan is. When you repay you are doing so with after-tax dollars... then those after-tax dollars will be taxed yet again when you make retirement withdrawals.
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Old 11-24-2012, 12:59 PM   #3
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I wouldn't repay the loan, except for the few months between taking the money and retiring. If I'm not required to pay during that period, I won't repay it at all. If I retire with the loan still outstanding, I believe the remaining balance is taxed as ordinary income just like any distribution.

So I guess the question is whether the convenience of having the rehab completed before I move in is worth the expense of the loan for 3-6 months. I could minimize the amount, and therefore the cost of the loan, by tapping other resources, like the remaining cash from the sale of my townhouse, the mortgage payments I'm no longer making, and taking contributions out of my Roth IRA to use for rehab expenses. I'm a little leery of doing that, because I don't know how to figure out exactly how much I can take out without tax implications--is it all contributions from the beginning of the account, all contributions that have been in for at least five years, or what? But I will just have to educate myself and/or ask my Mom's accountant who does her taxes.

edited to add: if I want to replace the money withdrawn from retirement savings ISTM a better option for me would be to wait until after I retire and get a part time job. I think I will probably meet the requirements for a deductible IRA and certain to meet those for a Roth. Since I will have enough to live on with my pension, I could just put my whole paycheck into retirement savings and probably wipe out that shortfall in a relatively short time. But I don't think a $10-15,000 decrease in my total retirement savings is make-or-break. It's just a high WR the first year of retirement, probably followed by at least a few years with no withdrawals at all.
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Old 11-24-2012, 12:59 PM   #4
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I found a list of items to consider with a 401k loan. The negative tax implication is mentioned.

401(k) Loans - Nine Things to Know About Borrowing from Your 401(k)

Maybe consider dividing the work into things that have to be done for safety or structural issue and things that are more cosmetic like paint, flooring etc that could be delayed.
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Old 11-24-2012, 01:47 PM   #5
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What type of rehab do you anticipate?

If it is interior work that is intensly disruptive, get it done before you move in.
If you need only a new garage door and some gutters, plus a new water heater, living there during const. would not be a problem.

I have seen people make the mistake of deciding to "camp out" during remodels and nearly destroy their homelife because of it.[ I used to build professionally]

On the borrowing, take the least expensive route, of course.
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Old 11-24-2012, 03:14 PM   #6
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Is this a 401k, or a deferred comp acct? In our megacorp, def comp cannot be tapped or borrowed against for anything other than serious financial hardship, such as debilitating illness (you would probably qualify, depending on how good your insurance is at covering your illness) or natural disaster such as Sandy or Katrina or an earthquake of devastating magnitude. Home purchases and related rehab would not be allowable reasons under our def comp plan.

Just another data point for you to check with your own plan, fwiw.

R
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Old 11-24-2012, 05:47 PM   #7
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Originally Posted by GrayHare View Post
Sounds like it would be the same bad idea that a 401k loan is. When you repay you are doing so with after-tax dollars... then those after-tax dollars will be taxed yet again when you make retirement withdrawals.
Uh, no, not this misinformation yet again? The loan principal is not double-taxed, but the loan interest that you pay in is taxed twice.

Consider this: You borrow $50,000 from your 401(k) and put it in your checking account. You use that money in your checking account to pay back the loan. Where is the double taxation?
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Old 11-24-2012, 08:52 PM   #8
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Quote:
Originally Posted by Rambler View Post
Is this a 401k, or a deferred comp acct? In our megacorp, def comp cannot be tapped or borrowed against for anything other than serious financial hardship, such as debilitating illness (you would probably qualify, depending on how good your insurance is at covering your illness) or natural disaster such as Sandy or Katrina or an earthquake of devastating magnitude. Home purchases and related rehab would not be allowable reasons under our def comp plan.

Just another data point for you to check with your own plan, fwiw.

R
It is a 457b plan, and loans do have to be approved. I started the thread because it hadn't occurred to me before this AM that requesting a loan was one of my options. It might still be a bad idea. But I do need to ask the plan's on-site rep about the rules for loans. I'll poke around online and maybe compose an email to him after dinner.
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Old 11-24-2012, 09:33 PM   #9
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Originally Posted by LOL! View Post
Uh, no, not this misinformation yet again? The loan principal is not double-taxed, but the loan interest that you pay in is taxed twice.

Consider this: You borrow $50,000 from your 401(k) and put it in your checking account. You use that money in your checking account to pay back the loan. Where is the double taxation?
Yes, I should have distinguished. A repaid loaned amount is not double taxed, but the interest on it is.
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Old 11-25-2012, 12:04 AM   #10
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(snip)Maybe consider dividing the work into things that have to be done for safety or structural issue and things that are more cosmetic like paint, flooring etc that could be delayed.
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What type of rehab do you anticipate?

If it is interior work that is intensly disruptive, get it done before you move in.
If you need only a new garage door and some gutters, plus a new water heater, living there during const. would not be a problem.(snip)
Most of the structural/safety stuff can be done after move-in, because it's exterior or in the crawlspace, and some of the cosmetic stuff isn't pressing, but would be much easier to do in a vacant house.

Specifically, I'm thinking of the floors. If they need refinishing, it would definitely be easier to do in a vacant house. There is wall-to-wall carpet throughout the house, but it's pretty well shot and an ugly color to boot. The living room has hardwood under the carpet, but I won't know what condition it's in until the carpets are removed. Maybe it only needs a good cleaning and waxing, not total sanding and refinishing. I also don't know yet whether the floors in the other rooms are also oak. I think that's the only thing that has to be done all at one time and would be a complete pain in the neck in an occupied house. The other item that I think also needs to be done before move-in is the work in the bathroom. There is only the one bath, so the house is uninhabitable as long as that's out of commission. But I think that is possibly only a one-day job.

I also plan to have the existing walls overlaid with new drywall, to cover an ugly texture that was applied some time in the past, which would probably also be easier in a vacant house, but not as bad as the floors, because the furniture just needs to go in the middle of the room, not be completely removed as it would for working on the floors. All other repairs that I can think of at the moment involve only a single room at a time, so could be done after the house is occupied, but still might be better/more convenient/less expensive if done on a vacant house.
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Old 11-25-2012, 05:21 AM   #11
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If I were in your position I would do it. It sounds like you are in good shape financially, and you will be much happier moving into a house that is all finished and how you want it for the long term. If need be, perhaps you could work a few extra months after you recover from surgery just until you can pay off the loan and get your retirement account balances back to where they were/where you feel comfortable retiring. Does that mean you will have a horrible commute, though? Anyway, I would think you could probably find some part-time/intermittant work over the long term to make up any difference. And the improvements you make to the house will increase its value and the long-term livability, which is important.

I'll be interested to hear how you like the Olympia area. It is one place we might return to if/when we move back to the US -- close enough to my family in the Seattle area, but much cheaper housing.

lhamo
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