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Borrowing from a 401k?
Old 01-05-2011, 01:09 PM   #1
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Borrowing from a 401k?

Hi all. I haven't posted on here in years, but I need some advice and you've all been so helpful in the past.

I have been making a lot of progress in the past few years, but I'm still struggling with some credit card debt. I've negotiated with my creditors and lowered my interest rates, sold my car, and moved in with three roommates to save money, but I'm still not happy with my debt. On top of this, I just started grad school, digging my student loan debt further into the hole.

I have $17k+ in my 401k and I modeled a loan scenario with Fidelity. I could borrow up to $8500 with a repayment interest rate of 5%. This is still lower than my credit card rates. My instinct is to use that money to pay down some debt, because I figure I'm still young enough and it's not that much money to make a huge difference in the big picture.

I guess I'm just looking for advice from anyone who has done this, and wondering if there are hidden dangers beside the obvious. Oh, and since the payments come straight out of my paychecks, is there a way to pay it back in full if I want to?

Any help is much appreciated as always! Thank you!

Jessica
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Old 01-05-2011, 01:49 PM   #2
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What are you doing in grad school? I would not go to grad school unless they paid me to go. What degree are you getting? How long will it take?

You must still be working if you have a 401(k) that would loan you money. If you stop working for that employer, is not the loan due and you have 90 days to pay it off? Could you do that if you lost your job? If not, then your balance is like an unqualified withdrawal with 10% penalty plus the income taxes on it.

My wife has a 401(k) loan. She can pay back in full anytime she wants. She borrowed the money in order to invest it in a 529 plan. That way the gains are tax-free and she also gets a lower expense ratio than her 401(k) offers. The term of the loan is at most 4 years as well.

So could you have a 529 plan for yourself and save the taxes on your gains?
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Old 01-05-2011, 02:20 PM   #3
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What are you doing in grad school? I would not go to grad school unless they paid me to go. What degree are you getting? How long will it take?
I'm going for my M.S. in Computer Information Systems and I'll be done in May 2012. My company offers $5k/year in tuition reimbursement which helps a little.

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You must still be working if you have a 401(k) that would loan you money. If you stop working for that employer, is not the loan due and you have 90 days to pay it off? Could you do that if you lost your job? If not, then your balance is like an unqualified withdrawal with 10% penalty plus the income taxes on it.
Even though my job pays crap (downside of being in a fun industry), I really love it and I don't plan on going anywhere at least until I'm done with school. If I got laid off, yeah - I'd be a little screwed. I can repay the loan within a year, but I'd prefer to do it in 18-24 months so I'm not totally screwing myself out of extra funds in an emergency.

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So could you have a 529 plan for yourself and save the taxes on your gains?
I don't know anything about 529 plans, but would that really make sense for me, since I'll be done with school in less than two years and already have student loans?
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Old 01-05-2011, 03:22 PM   #4
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There are only two reasons I would have borrowed money from my 401k plan (back in the day). If I didn't have enough money to eat or I had a serious health issue.
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Old 01-05-2011, 03:40 PM   #5
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I've done it several times for various reasons.

The concern I would have in using the money to pay off credit card debt is that unless you've stopped using the credit cards, the credit card debt will creep back up and now you'll have credit card debt and a 401k loan.
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Old 01-05-2011, 03:47 PM   #6
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No, no, no, do not borrow from your 401K--somewhere there are charts that show how much more your account will grow based on starting at an early age. Don't even think about it. Bite the bullet and get those CCs paid off with any spare cash you can get your hands on, but do not use the 401k for that debt.
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Old 01-05-2011, 04:28 PM   #7
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If the OP has the 401(k) invested in a bond fund, then it will not grow any slower than it would with the 401(k).

If a 529 plan is used and invested in a bond fund, then all the gains become tax-free. It's actually a win-win. Often a 401(k) plan has high expense-ratio funds, so one could save on those fees as well.

However, a 401(k) loan is limited to at most $50,000 and also to at most 50% of your 401(k) value. As such, that's just not a lot of money. You might save less than $1000 a year in the scheme I described, but $1000 is a $1000.
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Old 01-06-2011, 02:34 AM   #8
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Wow, a lot of what I said in a recent post applies here. I've selectively quoted it below.

It sounds like you're on the right track, and you're making progress. I spent about 5 years paying down $20k of credit card debt, and I had the option of withdrawing from a 401(k)/IRA, but at the time a 401(k) loan was unlikely due to job changes. (In other posts I mention $30k of debt at the peak, but $10k of that was a truck loan that was partially paid down and then covered by selling the truck for enough to cover the loan and buying a cheaper car at better terms and paying it off after paying off CC's.)

A side effect of planning ahead financially is being impatient for the plans to bear fruit. Let me tell you doing it the long was was worth it. I still have all my 401(k)/IRA investments which were earning money (or sometimes not so much) the whole time, and I had the confidence that I could control my spending and debt accumulation. It's an intangible knowledge that's worth a lot to me. In my 20's twice I got a debt consolidation loan to pay off CC's and then ran up the CCs again, so I didn't really trust myself with any instant-bail-out solution. I hopefully won't encounter the need for a bail-out again, but I am confident I can manage my money much better now.

I actually did take a 401(k) loan out in my 20's thinking I was going to use it for a down payment on a house. At the time my 401(k) was small...maybe $6k or $7k, and I borrowed half of it. I wound up not buying a house, but dipped into the withdrawn money and frittered much of it away. My 401(k) policy only allowed a one-time extra payment, so I couldn't pay it back at an accelerated rate. That was in the 90's during an incredible bull market. I often wonder how much I'd have today if I hadn't borrowed half my investments and paid it back slowly over 5 years of incredible growth.

I know it's frustrating to still be in debt while having long thought of where you want to be financially, but you're making progress. Keep making progress. I vote no on the loan.

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Originally Posted by BigMoneyJim View Post
[...]

It can be discouraging here to read people younger than you with more money, but once you pay off debt and start building savings you can look back at your history and see progress.

Here are some posts of mine at this forum going through similar decisions and processes:

Paying off Debt vs. 401(k) Contributions
Light at the End of the (Debt) Tunnel
Debt Countdown Update
Woohoo! Woohoo! Yippee! Happy!

It was in 2000 at age 30 I started taking better control of my finances, but at the time I had $60k in a 401(k). I was tempted several times to use the 401(k) to pay off the debt, but due to taxes and penalties it would have wiped out the 401(k). I think aggressively paying it down instead of cashing out has helped me learn to trust my ability to control spending and perhaps taught me how in the first place.

[...]

Edit: Reemphasizing: Don't get discouraged comparing yourself to others on this board. First, I think there is a bias for reporting success stories as people are hesitant to put out there "yeah, I screwed up some opportunities...." Make some financial goals and work towards them, but life happens, and sometimes that helps financial plans, and sometimes it wrecks them.
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Old 01-06-2011, 02:27 PM   #9
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Thanks everyone for the input! I'll hold off on borrowing from the 401k and try to be more patient.
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Old 01-06-2011, 04:55 PM   #10
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NO!

loans from a 401k are a terrible idea and do not work in your favor tho they may appear to (i get to pay myself back at X% rate what a deal... NOT). typically you can't contribute to the 401k when the loan is active (that was the way it used to be maybe that has changed) so you are losing out in growing your 401k. the worst thing is you pay the loan back with AFTER tax dollars and then when you take distributions in retirement you are taxed on that money A PAY TAXES ON THOSE DOLLARS AND 2ND TIME! lose your job or decide to change jobs, the loan is due in 60 or 90 days. these loans are just bad for you.

investing for retirement is a long term task. i have read so many examples of people who started early and contributed much less than someone that started just 10 years later and contributed 2x as much and/or the 1st person stopped after 15 years and the 2nd contributed for 25 years and guess who has more money at the end? time makes money, never touch your retirement accounts unless as previously stated it is life or death literally.
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Old 01-06-2011, 11:11 PM   #11
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If you are in graduate school, I take it that your 401k is sitting there from the time you still worked. Suppose you took the 401k loan out while working, and *then* you left the job. Then the rule is that the full amount of the loan becomes due. Because of that rule, my impression was that you *cannot* take out a 401k loan after you leave a job. If this is not the case, let us know, as it would benefit somebody I'm sure.
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Old 01-07-2011, 02:33 AM   #12
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Thanks everyone for the input! I'll hold off on borrowing from the 401k and try to be more patient.
Since your company's is helping to pay for tuition. Have you considered the possibility of either working part time and going to school full time or working full time and going to school part time. That is what I did for my MBA, sure it turned a two year program into a 4.5 year program, but end up paying of my student loans from undergrad rather than incurring more for grad school?
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Old 01-07-2011, 10:44 AM   #13
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Since your company's is helping to pay for tuition. Have you considered the possibility of either working part time and going to school full time or working full time and going to school part time. That is what I did for my MBA, sure it turned a two year program into a 4.5 year program, but end up paying of my student loans from undergrad rather than incurring more for grad school?
I am still working full time. There's no possibility of going part-time at my current job, nor would I want to.
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Old 01-09-2011, 02:53 PM   #14
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NO!

loans from a 401k are a terrible idea and do not work in your favor tho they may appear to (i get to pay myself back at X% rate what a deal... NOT). typically you can't contribute to the 401k when the loan is active (that was the way it used to be maybe that has changed) so you are losing out in growing your 401k. the worst thing is you pay the loan back with AFTER tax dollars and then when you take distributions in retirement you are taxed on that money A PAY TAXES ON THOSE DOLLARS AND 2ND TIME! lose your job or decide to change jobs, the loan is due in 60 or 90 days. these loans are just bad for you.
Of all the reasons not to borrow from a 401k, paying back the loan with after-tax dollars is not one of them. All loans you pay back are with after tax dollars and is no different than any other loan. You can google about it to see why it's not a big deal.

That said, I still would not borrow from it in your case. Just stay conservative and keep paying it back and continue making it a priority.

I took a 401k loan for a house downpayment and it worked out well for the numbers, I was still able to contribute to the 401k and receive the company match.
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Old 01-09-2011, 07:48 PM   #15
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===>"Of all the reasons not to borrow from a 401k, paying back the loan with after-tax dollars is not one of them."

i strongly disagree! say you borrow $10,000. you need $13,400 NOT counting any state taxes if you are in the 25% bracket to get $10,000 after taxes to pay off the loan. then in the distribution phase you'll pay taxes on that $10k again when you take distributions.

i can't imagine how this is not a terrible idea.
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Old 01-09-2011, 08:36 PM   #16
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===>"Of all the reasons not to borrow from a 401k, paying back the loan with after-tax dollars is not one of them."

i strongly disagree! say you borrow $10,000. you need $13,400 NOT counting any state taxes if you are in the 25% bracket to get $10,000 after taxes to pay off the loan. then in the distribution phase you'll pay taxes on that $10k again when you take distributions.

i can't imagine how this is not a terrible idea.
Here's one of the better examples I've seen debunking the 401k double taxation: 401k Loan Double Taxation Myth - The Finance Buff

You can also search for 401k double taxation myth to find others.

That said I still don't think a 401k loan is wise in this scenario, but for other reasons than the double taxation argument.

Here's the key part:

"Now, back to our 401k double taxation myth. The fact that the loan has to be repaid with after-tax dollars is irrelevant, just like the $30 number in the hotel puzzle. If you didn’t borrow from the 401k plan but you borrowed from a bank, you’d have to pay the bank back with after-tax dollars as well. If you didn’t borrow from your 401k plan but you dipped into your own savings, you have to replace those savings with after-tax dollars too. What it really means is that a 401k loan is not tax deductible, just like any other consumer loan except a mortgage or a HELOC. Instead of saying you will be double taxed, they should just say that a 401k loan is not tax deductible, plain and simple."
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Old 01-10-2011, 09:55 AM   #17
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If you are in graduate school, I take it that your 401k is sitting there from the time you still worked. Suppose you took the 401k loan out while working, and *then* you left the job. Then the rule is that the full amount of the loan becomes due. Because of that rule, my impression was that you *cannot* take out a 401k loan after you leave a job. If this is not the case, let us know, as it would benefit somebody I'm sure.
Oddly, it may be possible to borrow money from a 401k after you leave a job. We had a person who wanted to do that who was retired from my old firm. It turned out that they could do so under our plan. Yet, you are right that if you have an outstanding 401k loan it may be considered a distribution under your plan when you leave you job. The plan likely will allow something like 60 days to pay it off or you face income taxes and likely penalties on the distribution.
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Old 01-10-2011, 11:29 AM   #18
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Suze Orman's show this week was primarily focused on 401k loans and/or hardship withdrawals. Her advice was the loan should be your very last resort. She is strongly against doing a loan to pay off credit card debt. She even suggested you were better off to declare bankruptcy to discharge the credit card debt than to do a 401k loan!

I did use 401k loans early in my career to wipe out some high interest debt. No telling how much that really cost me because that was in the early 90's when the markets were going pretty well.

Don't do it!
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