401k loan strategy

[ndnguy822000]

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

 

[athena53]

My son once asked my advice about taking out a 401(k) loan to pay off his wife's car loan. Different case, I know, but the kiss of death was when I reminded him that if he left that job for any reason- voluntary or involuntary- if he didn't pay the loan back within 60 days it would be considered a taxable withdrawal.

Would you be able to handle that scenario?

 

[ndnguy822000]

My son once asked my advice about taking out a 401(k) loan to pay off his wife's car loan. Different case, I know, but the kiss of death was when I reminded him that if he left that job for any reason- voluntary or involuntary- if he didn't pay the loan back within 60 days it would be considered a taxable withdrawal.

Would you be able to handle that scenario?

Yes I keep about 30k in reserves for matters like this.

 

[Pilot2013]

My son once asked my advice about taking out a 401(k) loan to pay off his wife's car loan. Different case, I know, but the kiss of death was when I reminded him that if he left that job for any reason- voluntary or involuntary- if he didn't pay the loan back within 60 days it would be considered a taxable withdrawal.

Would you be able to handle that scenario?

I think this varies by 401k program? Some companies allow you to continue to pay if you keep the 401k... I have heard someone say that before, not sure if true.

In the largest majority of cases, however, I do think you are stuck with full repayment. That should be planned for, and sounds like OP has done that.

The other consideration is that while you are paying yourself 3%, you forego the other 7% assuming a 10% growth.

I've never really had a big problem with people that choose to do that like some, just another avenue IMO.

 

[CRLLS]

My son once asked my advice about taking out a 401(k) loan to pay off his wife's car loan. Different case, I know, but the kiss of death was when I reminded him that if he left that job for any reason- voluntary or involuntary- if he didn't pay the loan back within 60 days it would be considered a taxable withdrawal.

Would you be able to handle that scenario?

^+1

OP, If you never touch that 30K reserve to keep it available for this possible scenario, what is the difference of just using that 30K for the down payment and foregoing the 401K loan?

 

[ndnguy822000]

^+1



OP, If you never touch that 30K reserve to keep it available for this possible scenario, what is the difference of just using that 30K for the down payment and foregoing the 401K loan?

That reserve is for business emergency and peace of mind.

 

[ndnguy822000]

I think this varies by 401k program? Some companies allow you to continue to pay if you keep the 401k... I have heard someone say that before, not sure if true.



In the largest majority of cases, however, I do think you are stuck with full repayment. That should be planned for, and sounds like OP has done that.



The other consideration is that while you are paying yourself 3%, you forego the other 7% assuming a 10% growth.



I've never really had a big problem with people that choose to do that like some, just another avenue IMO.

I have thought about the 10% growth factor however those funds wouldn’t be available today and only add to the 401k which I can’t touch until I retire.

 

[workburnout]

My son once asked my advice about taking out a 401(k) loan to pay off his wife's car loan. Different case, I know, but the kiss of death was when I reminded him that if he left that job for any reason- voluntary or involuntary- if he didn't pay the loan back within 60 days it would be considered a taxable withdrawal.

Would you be able to handle that scenario?

With the new tax law, this will not be an issue. Here is a Forbes article on it. https://www.forbes.com/sites/ashlea...lizes-401k-loan-repayment-rules/#4547494d40f7

 

[CRLLS]

That reserve is for business emergency and peace of mind.

My point was that if you loose your job and have to pay back the loan, then if you have a general-use emergency fund, it may be needed for other needs. I personally have lost my job 2x when they decided to close shop. I was out of work for > 1 year both times. If I had to pay back a 401K loan , it would have cost big $$.

I wasn't aware of the new laws regarding extending the repayment rules.

 

[jazz4cash]

I would do it as you seem to be well versed in the details. It is definitely true that some plans permit repayment after the end of active employment. Mine does but I retired so maybe another type of separation would trigger repayment. I highly suggest adjusting your asset allocation so that the loan proceeds represent the cash/fixed income segment. That way the cost of your loan is fixed. The interest rate on the loan is not as significant as the opportunity cost. That is also why it is good to repay ASAP.

 

[Montecfo]

I would not incur debt to preserve and emergency fund. You are in essence borrowing your emergency fund. Why?

 

[Scrapr]

Worst case scenario you lose your job right after taking the loan. Place of employment burns down, does a Harvey Weinstein, etc. Unforseeable. You have to take your $25k to repay your loan. Your emergency fund is $5k. And you are unemployed.

True you have other assets to hold you over. What if we were doing 2008 over again and your investments were 50% lower? And you have to withdraw at the same time. Perfect storm

I would not do it because I am lucky enough to do it at the exact worse time

 

[joeea]

The other consideration is that while you are paying yourself 3%, you forego the other 7% assuming a 10% growth.

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.

 

[Pilot2013]

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.

I am assuming (although I didn't say it, and to make the math easy) that you would have to pay 3% to someone else to borrow other than from yourself...

 

[joeea]

I am assuming (although I didn't say it, and to make the math easy) that you would have to pay 3% to someone else to borrow other than from yourself...

The OP indicates that he already has a source of "emergency" funds he could use without borrowing. Many others could just delay a purchase and save the money until they had enough.

The main point is that you would lose the full 10% growth for the duration your money was absent from your 401k. And you pay back a 401k loan with after-tax money! That's a bad thing, and should only be a last resource. I don't believe that treating your 401k like a piggybank or credit card is a good thing.

I have enouraged my sons never to borrow from their 401ks. So far, so good.

See also: https://www.investopedia.com/articles/retirement/06/eightreasons401k.asp

 

[Pilot2013]

I would not incur debt to preserve and emergency fund. You are in essence borrowing your emergency fund. Why?

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.

 

[Pilot2013]

The OP indicates that he already has a source of funds he could use without borrowing.

Which apparently he prefers to hold.

It's really just a calculation, and risk assessment

 

[exnavynuke]

I have thought about the 10% growth factor however those funds wouldn’t be available today and only add to the 401k which I can’t touch until I retire.

Why not liquidate your 401k and use all the money now... and stop contributing so you can use all the money now too?

The answer to those questions is the same answer to yours - you don't sacrifice your retirement savings and it's growth while your working because it is needed for your retirement, that's its whole purpose. Taking it now, and losing out on all that growth makes just as much sense as not putting it away in the first place. Either way, you're losing out on the growth and compounding that is the whole point of putting the money away now.

 

[workburnout]

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.

Yes if you are in a plan that gives 10 percent growth, that is correct, and likely the case for a lot of people. Now, if you are in a plan with limited options and not getting good growth, that is a different story.

 

[joeea]

Yes if you are in a plan that gives 10 percent growth, that is correct, and likely the case for a lot of people. Now, if you are in a plan with limited options and not getting good growth, that is a different story.

The actual numbers might be different (5%, 8%, 10% - why would that matter?), but the story remains the same, IMHO.

 

[Pilot2013]

Why not liquidate your 401k and use all the money now... and stop contributing so you can use all the money now too?

The answer to those questions is the same answer to yours - you don't sacrifice your retirement savings and it's growth while your working because it is needed for your retirement, that's its whole purpose. Taking it now, and losing out on all that growth makes just as much sense as not putting it away in the first place. Either way, you're losing out on the growth and compounding that is the whole point of putting the money away now.

I've often heard that view, but think it's a little elementary.

Should someone, who has contributed for 20 years at high level to 401k, but then finds themselves in a situation that requires borrowing to get out of (hypothetical), not elect to borrow from himself, paying himself interest, rather than from a CC or some other means where they must pay someone else interest for the "privilege" to borrow?

Yes, this should not be an easy out (which is in the eye of the owner in this case), but I don't think one can say that it is NEVER apprpopriate. JMHO

 

[workburnout]

The actual numbers might be different (5%, 8%, 10% - why would that matter?), but the story remains the same, IMHO.

It matters because if you can get a far better return elsewhere, taking a loan makes sense.

 

[exnavynuke]

I've often heard that view, but think it's a little elementary.

Should someone, who has contributed for 20 years at high level to 401k, but then finds themselves in a situation that requires borrowing to get out of (hypothetical), not elect to borrow from himself, paying himself interest, rather than from a CC or some other means where they must pay someone else interest for the "privilege" to borrow?

Yes, this should not be an easy out (which is in the eye of the owner in this case), but I don't think one can say that it is NEVER apprpopriate. JMHO

That's a different situation completely. "In financial need" is not the same thing as "I want to use that money now instead of waiting for it". The former being why hardship loans etc are allowed, the latter being a good way to rob yourself of gains and compounding in your retirement account without needing to do so.

I don't think 401k loans are "never" appropriate, but I would never call them appropriate in the way the OP is talking about using them.

 

[Ready2Go]

Another consideration I didn't see mentioned is the double-taxation. Assuming this is a traditional (non-Roth) 401k, you will be paying the loan back with after-tax money. And guess what, it's going to be taxed again when you withdraw the money in retirement.

 

[ndnguy822000]

Another consideration I didn't see mentioned is the double-taxation. Assuming this is a traditional (non-Roth) 401k, you will be paying the loan back with after-tax money. And guess what, it's going to be taxed again when you withdraw the money in retirement.

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