Employees Raiding 401Ks to Pay Bills

[bamsphd]

Just to confuse things further

My credit union is currently offering a 15 year fixed NPNC mortgage with an interest rate of 6.50%.

My 401k is currently offering me a 10 year mortgage with an interest rate of 9.50% for the purchase (not refinance) of a house, or a 5 year consumer loan also at a 9.50% rate.

My 401k website says my "Personal Rate of Return from 01/01/2007 to 12/14/2007 is 3.9%." My 401k has spent the year 100% invested in a mix of Vanguard's S&P 500 and Extended Market index funds using the institutional share class with expense ratios of 0.05% and 0.07% respectively.

The other fine print is that I can borrow at most $50,000 from my 401k despite having a much larger vested balance. I can continue to contribute to my 401k and continue to receive the company match while I have an outstanding loan.

I'm not going to do it, but with those numbers my 401k balance would be better off if I had taken out a loan this year!

[Martha]

I am so tired of Orman's "double tax" claim about 401k loans. Only the interest you pay on the loan is taxed twice. You borrow the money and use it. That money was never taxed. So, when you put money back into the 401k you will have to pay tax on it when you take it out.

The big issue with borrowing money from a 401k is losing the growth of the funds that would occur while in the 401k.

[free4now]

Quote:

Originally Posted by Martha I am so tired of Orman's "double tax" claim about 401k loans. Only the interest you pay on the loan is taxed twice. You borrow the money and use it. That money was never taxed. So, when you put money back into the 401k you will have to pay tax on it when you take it out. The big issue with borrowing money from a 401k is losing the growth of the funds that would occur while in the 401k.

Right as always Martha. I was curious about this Orman quote, so I tracked it down. Here's the link to the article where she says:

Quote:

Never ever borrow against your 401k plan because you will pay double taxation on the money you borrow. Because you don't pay taxes on the money you put into a 401k, when you pay back the loan (which you must do within five years, or 15 years if used to buy a home), you pay it back with money you have paid taxes on. Then, when you retire and take the money out again, you end up paying taxes on it a second time.

I made the same incorrect argument earlier in this thread where I wrote:

Quote:

You pay back the money with post-tax dollars, and then you'll have to pay tax on that money again when you take it out of the 401k upon retirement.

So I hereby retract that.

But still there are two ways that you pay more tax with a 401k loan than on a deductible HELOC loan: the lost tax free compounding, and the loss of the interest payment deduction. It's just not the two ways that come to mind first!

[UncleHoney]

Now I'm really confused. (Not hard to do these days)

Here are the rules from my 401k plan with Vanguard. They even tell you you repay with after tax dollars and then get taxed again when you make withdrawals from the plan.



Although the Plan is designed for long-term savings, you may borrow from your account and pay yourself back with interest. Following are the loan provisions:

• Minimum loan amount: $1,000.
• Maximum loan amount: 50% of your vested account balance up to $50,000 (or less if you have had an outstanding Plan loan in the past 12 months).
• Maximum outstanding loans: two (with only one primary residence loan outstanding at any time).
• Repayment period: up to 5 years for a general purpose loan; up to 15 years for a primary residence loan.
• Loan application fee: $40 (one time only; deducted from your loan amount).
• Loan maintenance fee: $25 (annual; only applies to loans requested from Vanguard; deducted from the balance in your account).

Your Plan gives you the option to make an early lump-sum loan payoff.

Note: Your Plan does not allow partial payments. When you are ready to pay the loan in full, follow the steps listed under Take Action.
Take Action
Before taking a loan, consider the following.

• You reduce the amount of savings available to grow and compound for your retirement.
• You may have to work longer to make up lost ground.
• You have to pay the entire balance within 60 days if you end employment.
• You pay your loan back with after-tax dollars, and then you pay taxes on the money again when you withdraw it at retirement.
• You pay a one-time loan application fee of $40 and an annual maintenance fee of $25 for the life of your loan.

[UncleHoney]

I think I see the light now. You didn't pay tax on the original money and didn't have to pay tax on the loan money. So you got maybe $50k to use tax free. Now you have to earn another $50k and pay taxes on it and then pay the loan back then pay taxes again when you make withdrawals. So in the end you pay taxes on $100k. All comes out in the wash.

[free4now]

Quote:

Originally Posted by UncleHoney All comes out in the wash.

Right. You do pay tax twice on 401k loans, but you also pay twice with any other loan so it makes no difference. All loans are paid back with post tax dollars, not just 401k loans so that is not a concern. And you will pay tax on your 401k withdrawals whether you have previously used 401k loans or not so that also comes out in the wash.

[jazz4cash]

Wow- This really got twisted. I think we agree 401k loans are generally not a good source of funds and should only be used when no other options are available. Therefore if you're choosing between a 401k and a HELOC, for example....you don't get it. As I tried to stress, these are NOT LOANS....loans involve other people's money. I ve said before that using the term loan confuses most people and some other term should be used. 401k Loans are NOT MORTGAGES, so the interest will not be deductable.

I look at it as the only thing better than a withdrawal. Knowing that I can borrow in an emergency helps me justify a higher contribution rate...part of my emergency funds are in my 401k. When I have taken loans, I keep them very short if possible...like 6 months or just until I can get the funds some other way. I arrange the loan such that it is comming out of the fixed income portion of my AA which fixes the 'cost' of the loan and I do not give up any capital appreciation from my stock allocation.

Finally, I too am soo sick of Suze's nonsensical 'double taxation' argument, but it is probably effective at discouraging people from raiding thier 401ks.

[samclem]

Quote:

Originally Posted by jazz4cash Finally, I too am soo sick of Suze's nonsensical 'double taxation' argument, but it is probably effective at discouraging people from raiding thier 401ks.

Funny that in this same thread we have touched on two popular financial "entertainers" (Ramsey and Orman) who have given their listeners a good rule of thumb, but in each case their rationale for recommending it is faulty.

[Helena]

Quote:

Originally Posted by samclem Funny that in this same thread we have touched on two popular financial "entertainers" (Ramsey and Orman) who have given their listeners a good rule of thumb, but in each case their rationale for recommending it is faulty.

Their rationale is not faulty.

[RunningBum]

Quote:

Originally Posted by Helena Their rationale is not faulty.

Let's try it this way. You took a "loan" out of your 401K, and used that money without having to pay any tax. You didn't pay a tax when you put it in the account, and you didn't pay a tax when you disributed it in the form of this loan. So at this point you are actually -1 in paying taxes.

When you pay it back with after tax money, you are just getting it back to where it should be. You are back at 0 on taxes.

Then when you withdraw it in retirement, you actually pay your single tax on it.

I haven't gotten my arms around whether the interest is double taxed. Looking at the loan portion of it, whether it is interest to a bank or to your 401K, that money is gone. Inside the 401K account, that principal was going to make money, either on your loan from outside the account or from other investments in the account, so you'll pay taxes on that profit either way. So I don't think it does.

The way to calculate this is to use the same rate for your 401K loan, an alternative loan that is not tax-deductible (i.e., not a home equity loan), and your 401K investment return had you left it in the account. If the numbers work out the same for taking the 401K loan or leaving the 401K funds alone and taking an alternate loan, there is no extra tax. And I think they will work out the same if the rates are all the same.

[mathjak107]

i have written susie many times correcting her logic on the double taxation thing, i even requested her to show me at what point in any year you paid more in taxes whether you took a 401k loan or not.....

never an answere.

[mathjak107]

its no different than taking 10,000 out from your 401k as loan. deciding you didnt need the money and putting it back in. there is noooooo extra tax paid. she forgets your income you earn is taxed whether you pay back a 401k loan or a bank loan with it or not. the 401k loan is like taking back the income you earned and never paid taxes on it so you still owe taxes which you pay only once on withdrawl.

[saujanya]

double tax would mean that I pay tax today (i.e when i make the monthly payment on 401K loan) & when I withdraw (say, at retirement).
someone already mentioned that you will pay taxes on your income whether you are repaying 401k loan or any other non-home loan.
Further, lets say, I make $100,000/yr & lets say flat tax rate 25%, I would pay $25,000 in taxes this yr. If, this year I have also taken a 401K loan, I am still paying only $25,000 in taxes this yr for $100,000 income.
So, I will only pay tax on my 401k money at withdrawal. That only once.
"you are paying back 401k loan with "after tax" money is misleading.

[mathjak107]

its only the interest you are taxed on 2x. i think because of the catagory of people who watch her she says that double taxation thing to try to discourage people from hitting their retirement money. non the less she is still wrong

[TargaDave]

Quote:

Originally Posted by Helena You are kidding, right ? The value of a car decreases considerably with increase in age and mileage, etc... while a house, traditionally, increases in value. But everyone knows that, right ?

You are kidding, right? Land can increase in value, buildings and structures depreciate and break down just like cars. Maybe not as fast but much bigger $ involved. Ever rebuild a septic system, update a heating system, replace a full set of failing windows, or sell a house with a completely outdated look or internals? Sorry, didn't mean to take a swipe but, everyone knows that, right? Just ask LGFNB about an older structure on a prime lot.

[Razor]

Quote:

Originally Posted by FinanceDude I have a dumb question....why is it that the bride's family has to pay the whole thing? Other than tradition, it doesn't seem that smart financially.........:confused:

Sometimes traditions suck.
I believe the bride and groom should pay for their own wedding. It would be a good lesson about money and they might appreciate it more. I have seen some of the most lavish weddings paid for by modest income parents end up in divorce in just a few years. Just sickening. Not to mention that expensive gift I gave the couple. I want it back.

[mathjak107]

its not that way anymore, its split usually by all parties. my son just got married in sept and they wanted a big lavish afair. it approached 6 figures, i thought it was nuts but thats what they wanted. so we split it 3 ways

[Razor]

Quote:

Originally Posted by mathjak107 its not that way anymore, its split usually by all parties. my son just got married in sept and they wanted a big lavish afair. it approached 6 figures, i thought it was nuts but thats what they wanted. so we split it 3 ways

So it cost you 30 grand for one day? WOW.
I personally believe that parents shouldn't be made to feel they have to pay for any of it. It seemed to me that sometimes the bigger the wedding the shorter the marriage.

[Walt34]

Quote:

Originally Posted by Razor So it cost you 30 grand for one day? WOW. I personally believe that parents shouldn't be made to feel they have to pay for any of it. It seemed to me that sometimes the bigger the wedding the shorter the marriage.

I paid for both of mine. Neither bride's parents had the resources. But it wasn't anywhere near that much. DW's wedding dress came from J.C. Penny.

[Hamlet]

Yikes!

I got married in July last year for only about three thousand (60 people). We rented a room at a local park and had the ceremony in a little amphitheater outside. We had it catered picnic style by a local restaurant and brought the beer and wine ourselves.

It is very nice to have DW on the same page about things like this. She realizes that over the long term these expenses could mean the difference between having a cabin at the lake and not having a cabin at the lake. Or retiring several years earlier. Or having a much nicer house.

Quote:

Originally Posted by mathjak107 its not that way anymore, its split usually by all parties. my son just got married in sept and they wanted a big lavish afair. it approached 6 figures, i thought it was nuts but thats what they wanted. so we split it 3 ways