401k loan strategy

[ndnguy822000]

Assuming 10% growth, aren't you foregoing 10%?

The money you use to pay yourself 3% is coming from you. That's like taking 3 dollars from your left pocket, putting in your right pocket, and thinking you just made $3.

I would never advise someone to borrow money from a 401k when they had other sources to tap.

The reason I would borrow is because I put pre tax dollar $ into the 401k so that 3 dollars taxed would be more like 2

 

[ndnguy822000]

Thank you all for your opinions , highly respected and gives me perspective [emoji123][emoji1431]
MY PLAN TO RETIRE EARLY:
Currently make around 72k a year as an employee , I would like to have about 4K coming in per month from passive income via rental properties, hence the 401k loan. Having $ in 401k is useless until I’m 59 ish so I would like to retire or be able to have the option At 45 and focus on the rental stuff. Wife would continue to work which would take care of my insurance needs, I would like to take care of my parents who are near 70 now. That is my main reason and this community is perfect to motive and help me get real world opinions

 

[targatom2019]

Nguyen, I bought rental properties from 2006-2010 in SoCal making about 6-12% return on my money and those were the good old days. I don’t think you will get positive cash flow now with rental properties because the real state cost in SoCal is crazy expensive. FYI, To evict a bad tenant in SoCal takes at least 90 days even with the help from an eviction lawyer and if you have a mortgage then you are screwed.

 

[joeea]

That’s true but I’m borrowing from pre tax money therefore the payback would be from post tax money. So it’s not double taxation

You will still be taxed again when you withdraw the money during retirement.

 

[joeea]

The reason I would borrow is because I put pre tax dollar $ into the 401k so that 3 dollars taxed would be more like 2

I don't understand that logic.
You originally asked what people thought of your plan. But it sounds like you are set to do what you want and just wanted reassurance?

Good luck anyway. It doesn't make sense to me, but I still hope you succeed.

 

[Ready2Go]

You will still be taxed again when you withdraw the money during retirement.

Exactly! That's where the double taxation happens.

 

[joeea]

Exactly! That's where the double taxation happens.

The OP wrote:
"Wife and I pay a good amount in taxes but I usually put away 30% of my pretax income into my 401k to avoid paying taxes in California. I then grab about 25k loan @ 3% interest which is paid back to myself through biweekly payments."

So, in order to avoid paying taxes, the OP puts money into a 401k using pretax money. Then takes it out. Then repays it using post-tax money.

Then in retirement, the withdrawals are treated as ordinary income and taxed again.

So how does this "avoid paying taxes in California"?

 

[workburnout]

That’s true but I’m borrowing from pre tax money therefore the payback would be from post tax money. So it’s not double taxation

I borrowed from a Roth 401K as an example, because I got better returns elsewhere. If it had been a traditional then I might not have done it - would have calculated to see if it was worth it.

 

[ndnguy822000]

Nguyen, I bought rental properties from 2006-2010 in SoCal making about 6-12% return on my money and those were the good old days. I don’t think you will get positive cash flow now with rental properties because the real state cost in SoCal is crazy expensive. FYI, To evict a bad tenant in SoCal takes at least 90 days even with the help from an eviction lawyer and if you have a mortgage then you are screwed.

I’m in the Central Valley they are still decent prices and I would buy with 50% down payment

 

[ndnguy822000]

The OP wrote:

"Wife and I pay a good amount in taxes but I usually put away 30% of my pretax income into my 401k to avoid paying taxes in California. I then grab about 25k loan @ 3% interest which is paid back to myself through biweekly payments."



So, in order to avoid paying taxes, the OP puts money into a 401k using pretax money. Then takes it out. Then repays it using post-tax money.



Then in retirement, the withdrawals are treated as ordinary income and taxed again.



So how does this "avoid paying taxes in California"?

I didn’t mean avoid in general but putting off is more of the word I should have used.

 

[joeea]

I didn’t mean avoid in general but putting off is more of the word I should have used.

You aren't delaying the taxation of the 25k + 3%.

 

[ndnguy822000]

Well I’ve decided to avoid the 401k loan as I read your inputs , it makes sense . So today I’ve adjusted my 401k to only put $ in to the matching 6% company match and will just save extra $ and use that to buy property. [emoji1431]

 

[jazz4cash]

You will still be taxed again when you withdraw the money during retirement.

Think of it this way. After tax dollars will be used to either make the purchase or repay the loan. The amount of tax paid is the same except the amount representing "interest" does get taxed twice. That's why it's important to pay off the loan ASAP. Also reducing fixed income allocation within the 401k by the amount of the loan reduces the opportunity cost (e.g. Loss of growth) for the funds taken out for the loan. If the investment is successful it can more than offset the interest being taxed twice.
Another strategy is to roll funds into an tIRA or Roth and have the IRA make the purchase

 

[ndnguy822000]

Think of it this way. After tax dollars will be used to either make the purchase or repay the loan. The amount of tax paid is the same except the amount representing "interest" does get taxed twice. That's why it's important to pay off the loan ASAP. Also reducing fixed income allocation within the 401k by the amount of the loan reduces the opportunity cost (e.g. Loss of growth) for the funds taken out for the loan. If the investment is successful it can more than offset the interest being taxed twice.
Another strategy is to roll funds into an tIRA or Roth and have the IRA make the purchase

Thank you

 

[joeea]

Well I’ve decided to avoid the 401k loan as I read your inputs , it makes sense . So today I’ve adjusted my 401k to only put $ in to the matching 6% company match and will just save extra $ and use that to buy property. [emoji1431]

Nice!

 

[Hermit]

... Since I can’t use the $ in my 401k until 30 years ...

You can use your 401k at 55 with some strings so that makes you 25.

I didn't start saving anything until I was 40 and am quite comfortable in RE. Do whatever you want at your age. You will be OK. You might want to move to a little more conservative approach in the coming years.

 

[target2019]

How do you guys feel about 401k loans to fund a down payment for a rental property? Wife and I pay a good amount in taxes but I usually put away 30% of my pretax income into my 401k to avoid paying taxes in California. I then grab about 25k loan @ 3% interest which is paid back to myself through biweekly payments. I usually pay the loan back less than 2 years. Since I can’t use the $ in my 401k until 30 years this is the strategy I use to get income TODAY while using pretax $. The idea is to eventually have enough money from rentals to fund my life until I can tap into my 401k. I’m 36 and have about 230k in 401k and about 450k in real estate investments. I’m curious to hear your opinions. Thank you for your input

The result is that you pay back with interest out of your taxed dollars. In my mind, it sounds like you negate the original tax benefit.

I've started an informal family bank for situations like these. Say 2-3 individuals are involved, and each contributes $30K cash or investments like stock. One party borrowed 15K to pay for a car, and pays back monthly with 2% interest. When the cash total grows sufficiently (with payback of loan, etc.), a new loan can go out for a roof (30K).

 

[ndnguy822000]

You can use your 401k at 55 with some strings so that makes you 25.



I didn't start saving anything until I was 40 and am quite comfortable in RE. Do whatever you want at your age. You will be OK. You might want to move to a little more conservative approach in the coming years.

Stock market approach is very risky based on my allocation however my conservative side is the real estate and cash flowing

 

[Montecfo]

I think the answer is two fold (IMO):

1.) To not pay someone else interest (and yes, this assumes you are going to borrow anyway, because of 2...

2.) To maintain your emergency fund which with most people is a "comfort" thing.

I just do not subscribe to the idea of incurring, or continuing debt to fund or to maintain, an emergency fund. I think the emergency fund police have just oversold the logic and benefit.

The purpose of an emergency fund is to prevent you from taking out costly debt and avoiding needless financial risk. So a 401k loan is debt, could be high cost, nondeductible, could endanger retirement. Avoiding that is a worthy use of emergency funds, IMHO. There may be even better solutions.

I also do not find earning at 1% while borrowing at 6, 8 or 10% to be comforting.

I'm funny that way I guess .

 

[jazz4cash]

A 401k "loan" is funded with your own assets, so I don't consider it to be debt in the traditional sense. Yes it is a liability in that you could pay a penalty. I also disagree with the purpose of an emergency fund. The purpose varies according to an individuals circumstances. At various times I have relied on credit cards, 401k loans, or a HELOC as my emergency fund. I generally never used more than 5% of my balance and it was money that I put in with the idea of using for dependent tuition before 529 plans were available. When the time came it was easier to take a loan vs using the tuition exception.

 

[Montecfo]

A 401k "loan" is funded with your own assets, so I don't consider it to be debt in the traditional sense. Yes it is a liability in that you could pay a penalty. I also disagree with the purpose of an emergency fund. The purpose varies according to an individuals circumstances. At various times I have relied on credit cards, 401k loans, or a HELOC as my emergency fund. I generally never used more than 5% of my balance and it was money that I put in with the idea of using for dependent tuition before 529 plans were available. When the time came it was easier to take a loan vs using the tuition exception.

Oh it is a loan alright. It is a secured loan but has all the characteristics of a loan, including a uniquely punitive one: the "bank" ( your 401k trustee) can call the loan with little warning (i.e. if you get laid off) and subject you to what would otherwise be a usurious rate if it were an unsecured loan.

Not desirable features of a loan in my view.

I am ok with non-traditional emergency funds. Keeping huge balances invested at low rates carries a large opportunity cost.

 

[jazz4cash]

I just see it as another tool in my financial toolbox. It can be used or abused. What do you consider usury? I suppose it could be so if the loan was "called" in 6 months or less but I'd always have a plan B and C.

 

[SecondCor521]

You can use your 401k at 55 with some strings so that makes you 25.

You can also roll your 401k into an IRA and then do a Roth conversion pipeline and access the money in five years at any age, so that could mean as early as 5 years from today if the OP had the money to retire today.

 

[Montecfo]

I just see it as another tool in my financial toolbox. It can be used or abused. What do you consider usury? I suppose it could be so if the loan was "called" in 6 months or less but I'd always have a plan B and C.

I agree with that.

Usurious rate comment refers to not paying the loan back after losing your job, and having to pay say 25% fed state combined effective tax, plus 10% penalty tax.

Definitely a tool, but one of limited usefulness, in my view. But plan B and C could mitigate.

 

[jazz4cash]

OK, I see. I wasn't considering the income tax rate, only the penalty. It is income, after all.
BTW, I always take loans from my stable value account, so that limits my opportunity cost to 2% or less. Some 401k plans allow fund specific withdrawals, others require rebalancing to achieve this outcome.