401k loan for Kitchen Remodel

[Good_Life]

We bought our house about four years ago and the kitchen was ugly and dated and falling apart (one reason why we got the house for a decent price). I thought I would get used to the kitchen as I am pretty frugal and can deal with a lot, but my wife was getting more annoyed with it and I was too. We are at the point now of wanting to redo it. After getting some quotes total cost will be about $20-$25k.

Forecasting out I am at the threshold of the next tax bracket and I would really rather not sell investments and pay the taxes on them. I am planning/hoping my spending will be pretty low when I retire and I can actually stay at a low enough tax bracket to not pay LTCG.

My 401k loan program at work I think is actually a decent way to do this and would love all your feedback on it.

401k loan terms are:
-No fee
-My retirement funds remain invested
-I pay a variable rate (changes once per year) based on a bond index, currently about 4.1%

I was initially very skeptical of 401k loans, but as my retirement funds remain invested these terms seem very good. Compared to HELOC and home equity loans I see through PenFed/credit unions this 401k loan seems better. Main drawbacks are:

-is that it is variable and seems rates are only going up.
-I would have to immediately pay back the loan if my employment was severed.

Me leaving my employment is extremely unlikely as my job and work is extremely stable and even if I did I could then just bite the bullet and sell my taxable investments.

Like I said, I have always been led to believe that 401k plan loans are bad news, but this actually seems like a pretty good way to stay invested and limit taxes. Am I being crazy?

 

[davebarnes]

Your risk is about as close to zero as you can get.
Do it.
But, you need to increase your budget: blow that dough.
Consider doing it right with a Sub-Zero refrigerator.

 

[bobandsherry]

Just be aware that most plans require repayment should you terminate employment. If you plan to retire before loan is repaid you will need to find the funds to pay for the loan.

 

[rodi]

I've been brainwashed through the years to think this is a bad idea. I think I would figure a way to pay as you go on the kitchen remodel. Save up money for new counters one year. Next year reface the cabinets. Purchase new appliances along the way. New floors later.... Etc. That's how we did it. We now have the kitchen of our dreams and didn't incur any borrowing along the way.

 

[LiveBelowMeans]

Early retirement is all about deferring gratification. If you’re serious about retiring early you should not borrow from your 401k for this. The retirement money won’t grow while it is out of 401k. Suck it up. Save for the remodel and do it later. JMHO
LBYM

 

[CRLLS]

Just be aware that most plans require repayment should you terminate employment. If you plan to retire before loan is repaid you will need to find the funds to pay for the loan.

^ +1


For the safety, I'd prefer a home equity loan or similar. Maybe you have a loan rider on a life insurance policy? I've tapped into that 2x over the years. That way, if the S-H-T-F and you lose you job before expected, you won't be facing 2 money issues, loss of income plus a big lump sum loan payoff.

 

[Texas Proud]

I am curious how your funds remain invested?


IOW, every 401(k) loan program I have seen will take your money out of some investment to loan to you... so that means it is not invested...


Here I am a bit murky about this... but I also do not think you can pledge your assets as collateral for a loan... so if the company is using their money to lend you so yours are still invested that sounds like you are pledging your 401....


So, IMO, something smells a bit fishy here... not saying you are not right, but I have my doubts...

 

[Bigdawg]

I would use a 0% for 18 month credit card. 0 is less than 4.1%. Just saying. 25K/18 months is $1388/month. Can you afford that? If not then pay less and transfer to another 0% card at the 17 month mark.

 

[Good_Life]

I am curious how your funds remain invested?


IOW, every 401(k) loan program I have seen will take your money out of some investment to loan to you... so that means it is not invested...


Here I am a bit murky about this... but I also do not think you can pledge your assets as collateral for a loan... so if the company is using their money to lend you so yours are still invested that sounds like you are pledging your 401....


So, IMO, something smells a bit fishy here... not saying you are not right, but I have my doubts...

I was very surprised by the terms as well, but I double checked it with our HR last week. They use your retirement funds as collateral, but your retirement funds do stay invested. The 401k provider just collects interest on the money you borrow.

The HR rep is surprised more people do not use it as well as it seems to be a pretty cheap way to borrow money.

 

[Good_Life]

I've been brainwashed through the years to think this is a bad idea. I think I would figure a way to pay as you go on the kitchen remodel. Save up money for new counters one year. Next year reface the cabinets. Purchase new appliances along the way. New floors later.... Etc. That's how we did it. We now have the kitchen of our dreams and didn't incur any borrowing along the way.

I totally agree, and this is how I have handled all the other projects on my house. This one though due to appliance sizes and cabinet/counters it really only makes sense for us to do it all at once.

 

[Good_Life]

I would use a 0% for 18 month credit card. 0 is less than 4.1%. Just saying. 25K/18 months is $1388/month. Can you afford that? If not then pay less and transfer to another 0% card at the 17 month mark.

Hmmm... I actually like this idea although pretty sure I can't pay for the big costs cabinets/counters with whom I am using via credit card.

 

[Texas Proud]

I was very surprised by the terms as well, but I double checked it with our HR last week. They use your retirement funds as collateral, but your retirement funds do stay invested. The 401k provider just collects interest on the money you borrow.

The HR rep is surprised more people do not use it as well as it seems to be a pretty cheap way to borrow money.

I would go to the custodian and ask... quickly found this...

Although federal Internal Revenue Service, or IRS, regulations prohibit using a 401(k) plan as collateral for a loan, it is sometimes possible for an individual to obtain a loan directly from the 401(k) account.
​

I do not see how they can get around this restriction. If they lend you the money and do not take it out then the 401(k) is being used as collateral. Where is the money coming from?


BTW, this is also why you cannot have a margin account with a 401(k)... because you are borrowing money against your collateral.





https://www.investopedia.com/ask/answers/081715/can-i-use-my-401k-collateral-loan.asp

 

[pb4uski]

Just be aware that most plans require repayment should you terminate employment. If you plan to retire before loan is repaid you will need to find the funds to pay for the loan.

He said that in the OP. Did you read the OP?

 

[pb4uski]

I would go to the custodian and ask... quickly found this...

Although federal Internal Revenue Service, or IRS, regulations prohibit using a 401(k) plan as collateral for a loan, it is sometimes possible for an individual to obtain a loan directly from the 401(k) account.
​

I do not see how they can get around this restriction. If they lend you the money and do not take it out then the 401(k) is being used as collateral. Where is the money coming from?


BTW, this is also why you cannot have a margin account with a 401(k)... because you are borrowing money against your collateral.





https://www.investopedia.com/ask/answers/081715/can-i-use-my-401k-collateral-loan.asp

TP, what you quoted applies to someone approaching another borrower to use their 401k as collateral.... this is within the 401k plan.

While the 401k loans that I'm familiar with don't have the feature of keeping your funds invested... effectively you loan money to yourself at a reasonable rate of interest... if there is a quirk with the OP's plan that allows the money to stay invested then I think it is a no-brainer to use it.

 

[target2019]

I would use a 0% for 18 month credit card. 0 is less than 4.1%. Just saying. 25K/18 months is $1388/month. Can you afford that? If not then pay less and transfer to another 0% card at the 17 month mark.

Myself, I'd do as you recommend. If I couldn't get that credit deal, then would start saving for a year. I might have 12K, and then would need to borrow only 12-13K additional.
The 401K loan is such a great deal, I can't believe it.

 

[4legsgood]

I've been brainwashed through the years to think this is a bad idea. I think I would figure a way to pay as you go on the kitchen remodel. Save up money for new counters one year. Next year reface the cabinets. Purchase new appliances along the way. New floors later.... Etc. That's how we did it. We now have the kitchen of our dreams and didn't incur any borrowing along the way.

+1. My instincts tell me to never consider a loan for a remodel, smacks of living beyond your means. I think rules on this kind of loan sometimes don't allow for an early pay off so if part of your plan is to pay this off quickly, make sure that is allowed.

 

[jazz4cash]

Early retirement is all about deferring gratification. If you’re serious about retiring early you should not borrow from your 401k for this. The retirement money won’t grow while it is out of 401k. Suck it up. Save for the remodel and do it later. JMHO
LBYM

I don't agree that "ER is all about delayed gratification". Sometimes you can do both and still LBYM.

 

[Aerides]

For the amount you have planned, I would look at a new credit card with 0 interest for a year or so vs. touching my 401k, or just tapping into your cash/emergency funds and then paying that back first. While your loan option seems more flexible and less risky of an approach than most, I would still not want to touch that.

 

[jazz4cash]

Count me as skeptical on the funds staying invested. If it's true that's a great plan. It is my understanding that 401k and IRA funds cannot be used as collateral except I know our 401k limit was the lessor of 50% or 50k. I wouldn't rely on advice from HR without confirming it in the SPD or via the custodian. I have used 401k loans a few times and just rebalance out of stable value funds to minimize opportunity cost. I never borrowed more than 5% or so of my balance.
Home Depot has 24 months at 0% if you would consider them to supply some of the materials.

 

[RunningBum]

IMO people are too brainwashed against borrowing from a 401K.

OP has already considered the drawback of what happens if he gets separated from work, and has a plan for it.

I'm more familiar with the plan where your own 401K assets are reduced by the size of the loan. Instead of being fully invest in, say, a total bond fund, $25K will be "invested" in a loan, which you are paying back to the account at 4% interest. So the 401K is still fully invested and growing, and the rate only kind of matters. If you pay a higher rate, your 401K grows more, though note that you are funding it with after-tax money, which will be taxed again when you withdraw. If you pay a lower rate, the 401K grows less, but you pay less out of pocket.

I'm not familiar with the loan type where you assets stay fully invested, and you pay the 4% to the institution rather than to your account. That seems like it would be evaluated just like any other loan, with the risk you mentioned of repayment if you leave the company.

Those 0% credit card deals...can you get a $20K loan out of that? I'd be surprised.

Seems to me that you bought a house with a known shortcoming, the very dated kitchen, so this is an expected expense. You have money saved that could be used, but are looking at whether there's a more efficient way to pay for it, which might involve borrowing.

One thought, how much would you really pay in taxes if you sold $20-25K in funds? If you've made 20% on them, that would be 4-5K of income. 15% on that is $600-$750. One time. 4% loan interest on that would be $800-$1000. Of course the numbers change if your LTCG is greater, but don't fall into the trap of thinking the entire fund sales proceeds is taxed--it's just the gains.

 

[Texas Proud]

TP, what you quoted applies to someone approaching another borrower to use their 401k as collateral.... this is within the 401k plan.

While the 401k loans that I'm familiar with don't have the feature of keeping your funds invested... effectively you loan money to yourself at a reasonable rate of interest... if there is a quirk with the OP's plan that allows the money to stay invested then I think it is a no-brainer to use it.

Oh, I agree... but I have never seen a plan that allows you to stay invested... IOW, you take money out of some fund and a new asset is listed as a holding called loan to ...(cannot remember what they called it, I never got one)....


So, you are still invested, but your investment is your own loan and the income is the interest you pay...


I do not see how they can get around the rule... it does not matter where the money is coming from if it is not 'your' money... it is a loan using your 401 as collateral...


As always, I could be wrong as there might be some strange rule I have never heard of.....

 

[pb4uski]

IMO people are too brainwashed against borrowing from a 401K.

OP has already considered the drawback of what happens if he gets separated from work, and has a plan for it.

I'm more familiar with the plan where your own 401K assets are reduced by the size of the loan. Instead of being fully invest in, say, a total bond fund, $25K will be "invested" in a loan, which you are paying back to the account at 4% interest. So the 401K is still fully invested and growing, and the rate only kind of matters. If you pay a higher rate, your 401K grows more, though note that you are funding it with after-tax money, which will be taxed again when you withdraw. If you pay a lower rate, the 401K grows less, but you pay less out of pocket.

I'm not familiar with the loan type where you assets stay fully invested, and you pay the 4% to the institution rather than to your account. That seems like it would be evaluated just like any other loan, with the risk you mentioned of repayment if you leave the company.

Those 0% credit card deals...can you get a $20K loan out of that? I'd be surprised.

Seems to me that you bought a house with a known shortcoming, the very dated kitchen, so this is an expected expense. You have money saved that could be used, but are looking at whether there's a more efficient way to pay for it, which might involve borrowing.

One thought, how much would you really pay in taxes if you sold $20-25K in funds? If you've made 20% on them, that would be 4-5K of income. 15% on that is $600-$750. One time. 4% loan interest on that would be $800-$1000. Of course the numbers change if your LTCG is greater, but don't fall into the trap of thinking the entire fund sales proceeds is taxed--it's just the gains.

+1 I think I would try a 0% credit card combined with some asset sales as a more cost effective way of financing the kitchen remodel.

 

[Bamaman]

I would just borrow the funds from my credit union--even if it took putting up other assets as collateral.

That must be some kitchen. I bought new cabinets last year at Cabinets to Go for just over $3k for an average size kitchen for my daughter. I have a full hobby cabinet shop and can do basic cabinetry.

 

[Aerides]

That must be some kitchen. I bought new cabinets last year at Cabinets to Go for just over $3k for an average size kitchen for my daughter. I have a full hobby cabinet shop and can do basic cabinetry.

And for those who aren't as handy, $20-$25k for a full remodel is economical. I think we spent about double that, but went Robbie-Style. We tore out half a wall, removed a drop ceiling, all new appliances, lighting, granite, flooring, nice farmhouse sink... I balked at a $1000 faucet and settled on one for $800... and would not have come up with half of the ideas were it not for hiring a reputable design and construction company to do it for us.

Granted, our "before" kitchen...a small dark old cave. I would never have bought this house (it was already DH's). We turned it into the kind of kitchen that will make someone want to live here.

 

[Marita40]

My small new kitchen cost $30,000 two years ago, and that was with me being the GC and using a handyman for much of the work. I paid half in cash and half on a 0% credit card for 18 months. It was paid off in those 18 months, and was quite painless! It was a Chase Citicard.