We have been talking for a couple years about getting a toyhauler so we can bring our bike or ATVs on future trips. We also have our ongoing remodel project that continues to require money. Tempted to borrow from my 401K, half the interest than a RV loan, plus we can use the money anyway we want. Heck its doing nothing but loosing value anyway. The 401 has to be paid back max 5 years, so payment is way higher. We can sell our current 2 campers, putting it back on the loan, and once the house is done, we can look at an equity or HELOC if needed. The house is a need, the camper just a want.
Borrowing from your 401K?
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COcheesehead
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I assume you are still working. Why not take a HELOC for the remodel, that makes the most sense and forgo the toys. Pulling money out for depreciating assets when the investments are down is not a good plan.
pb4uski
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Old medic, if I recall correctly you are now retired. Most 401k plans only allow current employees to take 401k loans. In fact, one of the perils of 401k loans is that if you leave the employer or are fired or laid off that the loan becomes immediately payable.
jazz4cash
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I’ve used 401k loans many times while working and our plan did not require loans to be paid back at retirement. I still have access in retirement so that is sort of a back-up emergency, income smoothing option for us.
The most important thing to understand about 401k loans IMO is the concept of opportunity cost. The assets to fund the “loan” will be sold so if the market goes up while the loan is in repayment it increases your cost. It could go the other way as well and decrease your cost. I always took the loans by liquidating from the stable value fund so my opportunity cost was fixed and known. If a plan requires pro-rata liquidation to fund the loan you may need to rebalance so the loan only affects the stable value fund. If I didn’t have a stable value fund I might skip the loan except for emergency.
Forget about the whole paying yourself interest bit. That’s just smoke and mirrors.
The most important thing to understand about 401k loans IMO is the concept of opportunity cost. The assets to fund the “loan” will be sold so if the market goes up while the loan is in repayment it increases your cost. It could go the other way as well and decrease your cost. I always took the loans by liquidating from the stable value fund so my opportunity cost was fixed and known. If a plan requires pro-rata liquidation to fund the loan you may need to rebalance so the loan only affects the stable value fund. If I didn’t have a stable value fund I might skip the loan except for emergency.
Forget about the whole paying yourself interest bit. That’s just smoke and mirrors.
COcheesehead... I assume you are still working. Why not take a HELOC for the remodel?
No, I'm Retired with a pension, DW still working. Have tried for a HELOC but due to the original condition, The work has to be completed 1st.
pb4uski, Dash man... I'm still looking into the details, but had a loan when I started considering retiring.. and there was no real issue. had 2 choices, pay it off, or continue payments. But if you miss a payment, the outstanding balance was pulled from your account and taxed as a withdraw. I had paid our loan off and work another years before retiring.
No, I'm Retired with a pension, DW still working. Have tried for a HELOC but due to the original condition, The work has to be completed 1st.
pb4uski, Dash man... I'm still looking into the details, but had a loan when I started considering retiring.. and there was no real issue. had 2 choices, pay it off, or continue payments. But if you miss a payment, the outstanding balance was pulled from your account and taxed as a withdraw. I had paid our loan off and work another years before retiring.
You probably have better options. I took out a 401k loan to pay taxes when I became self-employed. I would have been better off with IRS payment plan or HELOC.
If I had to make the same decision today, I would use a HELOC. Today's rates:
401k: 4.5% interest rate, but you pay tax twice on the interest, which I did not realize at the time. (once when you earn the money to pay the interest, and second time when the interest is withdrawn). Plus all the other restrictions on repayment. Doesn't seem to show on credit report but lender may see if you submit that account as proof of funds.
IRS: 4% interest rate - payment plans (not liens) do not show on credit report. Wages earned to pay interest taxed once. Not tax-deductible.
HELOC: 4.375% interest rate - interest is tax-deductible (for your remodel project at least), more credit available than 401k or IRS. does show on credit report.
If I had to make the same decision today, I would use a HELOC. Today's rates:
401k: 4.5% interest rate, but you pay tax twice on the interest, which I did not realize at the time. (once when you earn the money to pay the interest, and second time when the interest is withdrawn). Plus all the other restrictions on repayment. Doesn't seem to show on credit report but lender may see if you submit that account as proof of funds.
IRS: 4% interest rate - payment plans (not liens) do not show on credit report. Wages earned to pay interest taxed once. Not tax-deductible.
HELOC: 4.375% interest rate - interest is tax-deductible (for your remodel project at least), more credit available than 401k or IRS. does show on credit report.
Well in a BTD move, We bought the camper. Took several start to walk away moments until we got them to agreed on a financing deal. Now the joy of cleaning out the old one and figuring what to put where in the new.
401k Loan is a good option in the right circumstance since 1) the interest is really non-existent since you pay it to yourself and 2) low rate/ easy terms. The downside is if you are terminated at work for any reason, you usually only have 60 days or 90 days to pay it back in full.
I've used them many times over the years. Just be aware of what your plan would be if you lost your job or left your job.
I've used them many times over the years. Just be aware of what your plan would be if you lost your job or left your job.
This myth simply will not die, probably because its much better for financial firms for you to use more expensive loans and to collect more fees from their 401k products.
You do not pay tax on the interest twice. All loans are considered after tax amounts and all payments on loans, including interest, require after tax dollars because you didn't pay taxes on the money from the loan. This is equally true for a 401k loan or a HELOC or a credit card debt. Zero difference. The only difference is the interest you pay on a 401k loan goes to YOU - the interest on a HELOC or credit card goes to a financial institution. Yes, when you withdraw the money in retirement many years later you may pay a smidge of taxes on that interest you paid yourself, however, that's still far better than losing 100% of the interest payment to a financial institution ($1 - a 5-15% tax) > ($1 - 100% going to financial institution).
Put more simply, the only cost to a 401k loan is the smidge of taxes, if any, in retirement you'll owe the government on the interest you pay yourself. The alternative is to not see any of the interest value at any point, taxes or not, because its all going to a financial institution.
The are exactly two reasons to potentially avoid a 401k loan: 1) You will have to repay it within 60-90 days in full if you leave the company or are terminated (which in the case of the latter is usually a bad time to need to repay it) or 2) you strongly believe you'll earn a much better return over the short and intermediate term with your 401k investments than the cost of debt or opportunity cost you'd have to do if you did not take a 401k loan and instead got a loan elsewhere.
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This again is simply not true. All loans and all interest are paid with after tax dollars, whether its 401k, HELOC, Credit card or pay day loan because the government does not tax loans and does not consider them income unless written off. It's no different for a 401k loan. You'll pay taxes in retirement on your 401k regardless of whether or not you take a loan against it. There is literally no difference. The single small difference is you'll pay a slight amount of taxes on the interest you paid yourself but its still better than losing all of the interest to a financial institution.
Do the math yourself in excel. If you borrow 10k from a bank and pay 5% interest over the year, you need $10,500 in after tax dollars to pay the bank back with interest. If you borrow $10k from your 401k with 5% interest, you need to pay $10,500 in after tax dollars to pay back your 401k. The main difference is your 401k now has $500 in interest collected and the bank has zero instead of the other way around. Yes, you'll pay taxes on the $10k in retirement upon withdraw however that is true regardless of whether you take a loan out now or not. Not one thing is changed about the principal amount of the loan with a 401k loan.
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Dash man
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Magus; said:
You say yourself all loans are paid with after tax dollars. So you take money out of your 401k that was deducted from your taxes, repay it with after tax funds on which you have paid taxes, then later when withdrawn you have to pay taxes on it a second time. Not a good deal!
This is flat out incorrect or no different than another loan type. You are paying after tax dollars on a loan that you paid no taxes on. This is true for a 401k loan or a HELOC or any other debt.
Here I'll give you a VERY simple example.
Let's say I have exactly $200 in my 401k and a credit card with a $100 open line and I need $100 today. I can borrow at 5% from my 401k or I can borrow at 5% from my credit card annually and I plan to pay it back after exactly one year. For the sake of this example to simplify the #s, let's say I have all of my 401k sitting in 0% interest cash and will until I retire and withdraw it. Let's also say for the sake of this example I will pay 10% in taxes in retirement on my 401k withdraw and I plan on withdrawing my entire 401k at once 20 years from now.
Option 1 - Borrow from bank
Step 1: 401k - Stays at $200 today. Bank lends me $100 and I pay no taxes on this loan. I spend $100 (net cash of $0)
Step 2: 401k still at $200 a year from now. I pay the bank back $105 in after tax dollars on the credit card.
Step 3: Retire - Withdraw $200 in 20 years and pay 10% taxes, for a net withdraw of $180 after taxes.
Total amount in retirement after taxes: $180; Total loan repayment with interest: $105
Option 2 - Borrow from 401k
Step 1: Borrow $100 from 401k. I pay no taxes on this loan. I spend $100. 401k Balance is now $100
Step 2: In one year, I pay back 401k $105 with after tax dollars. 401k Balance is now $205.
Step 3: Retire. Withdraw $205 in 20 years and pay 10% in taxes, for a net withdraw after taxes $184.5
Total amount in retirement after taxes: $184.5; Total loan repayment with interest: $105
I'm better off in scenario 2 than scenario 1 with a total net worth increase of $4.5 after taxes as that is exactly the mechanics of the loans in both cases.
Now, it is more complicated because most people don't park their 401k investments in 0% cash so the value can go up or down in between but taxes and "double taxes" have zero to do with the decision to borrow from your 401k or some other source. All loans are paid with after tax dollars, period. Otherwise the government would count the loan as income. And your 401k will be taxed in retirement whether or not you borrow against it. This is what is known as a sunk cost, and its because you received a tax deduction for the initial entry. A 401k loan in no way changes this mechanic.
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Dash man
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You’re missing my point.
Original contribution to 401k $100.
That $100 did not have taxes paid on it.
Later you borrow $100.
After one year you repay $100 + $5 interest that cost you $105*1.12 (12% marginal tax rate) or $117.60. You had to earn that $105, so you had to pay tax on it.
Later you withdraw the $100 for living expenses and again pay tax on the $100 of 12%, leaving you $88.
The $100 loan cost you $29.60 for one year.
This is simply incorrect. There is no incremental 12% taxes on the 401k loan vs borrow elsewhere. Look again at my example. That is exactly how a loan works both with and without a 401k loan or alternative loan. You are lumping in a sunk cost (tax in retirement at withdraw) with the loan cost, even though the two have nothing to do with each other. Again look at the example I just gave as that is exactly how it works. You have to make the same $117.60 pre-tax to pay back the bank the loan with interest in your example. It's no different on the front end or back end.
Long story short: You are not adjusting the bank loan for the tax cost even though its the same as the 401k and your taxes owed in retirement the base is already a sunk cost. IOW I need to make $117.60 pre-tax to pay the loan back regardless or whom the lender is (myself or the bank) and the $100 withdraw in retirement is going to be taxed 12% in your example with or without the 401k loan. The only new piece is the incremental interest in my 401k, which I showed in my example.
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Dash man
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There is no tax on the loan. But you have paid taxes in the money to repay the loan, and will pay taxes upon eventual withdrawals of the funds. You are basically removing the tax advantage of the 401k funds if they are borrowed and repaid.
So you’re saying the money used to repay the 401k has never been taxed?
Then we simply disagree.
The first part is true but equally true for a traditional loan as you must pay taxes on all income to pay any loan. There is no loss in tax value to the 401k.
No that is not what I’m saying at all. I’m saying this is the same situation as borrowing the money from the bank. In your example I need to make $117 to repay the loan no matter whether it’s my 401k or Citi bank so it’s no better or worse than the other except the $5 in interest goes to my 401k instead of citi. The 12% I’ll pay in taxes to repay the loan is there but it’s not different in either situation than the other.
Seriously walk thru my example above, adding the $117 income in both options needed to repay either loan. It’ll click eventually
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jazz4cash
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It’s not the taxes on the dollars to repay the loan. I agree it’s the same for any loan. It’s the fact the interest is taxed again as regular income when withdrawn in retirement. The amount may be trivial but it is actually taxed twice. I agree it may still be better than other options and I have used 401k loans many times. I think the opportunity cost is a far bigger concern if you liquidate equities for the loan.
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Oh right...I think borrowing (without tax penalties) is very strict in a lot of plans, and needs to be specifically for home purchase.
Until 59.5 that is now most all 401ks work, then it's withdrawals only. Before that, wd with tax penalty, with the only exception being rule of 55, which is far from universal and has it's own limits.
Until 59.5 that is now most all 401ks work, then it's withdrawals only. Before that, wd with tax penalty, with the only exception being rule of 55, which is far from universal and has it's own limits.
There no interest that is "taxed again." You paid taxes on income you made to pay back your loan - 401k or bank loan - doesn't matter which - in most circumstances - although not all - could be primary home sale repayment with no taxes or sale on something with no taxes.
Then you *may* pay taxes on the interest you paid yourself in a 401k in withdraw depending on your circumstances (most on this Board would likely pay something in taxes, but in aggregate, a huge amount end up paying nothing since such small 401ks and only other income is SS). But that tax is only once at most - at withdraw. As long as the tax in retirement is < 100%, you are better off with a 401k loan than a bank loan EXCEPT for the two big things I've already mentioned - if you are laid off or quit, you'll have to pay back the loan in full, which for folks taking a loan could cause a major problem - and the interest you pay yourself may be significantly lower than market returns (although, certainly not always the case like the last year, or 2000-2010). If you are bearish on the market AND highly confident in your job stability, a 401k loan is a spectacular use of a loan but you should go in knowing the risks.
Otherwise your logic is all investment income is taxed twice - once you made the money to invest in an asset and again when you get distributions or sell the asset. Which, again, would be no different than the 401k loan.
You have to remember there is a lot flat out false propaganda or drastically miss-construed information against 401k loans - financial institutions HATE them because they lose twice 1) Less juice on your 401k balance and 2) they don't make money on the loan since the interest is just going from one of your accounts (checking/savings) to another (401k) rather than from your checking account to the banks account.
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jazz4cash
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You keep making these contradictory statements. Unless your income is very low at withdrawal the “interest” on loan payments “will” be taxable. I think you could make a good argument that this tax is negligible, so I won’t continue to debate the point. I’ve used many 401k loans so I am an advocate under the right circumstances. The bigger issue IMO is minimizing opportunity cost.
What I said is in fact not contradictory at all and is the mechanics for how both a traditional bank loan and 401k loan work. You pay tax on the interest once - not again - at retirement upon withdraw only. You pay taxes on your w2 income to pay for the loan, not the interest expense, which is also true for any loan. If you saved $10k (12k pre tax with $2k taxes) and then invest the $10k into P&G stock and get $250 in dividends which are taxed at 15%, do you consider you’ve paid taxes twice on the dividend? Because that’s the exact same thing you are arguing for the 401k loan. Similar let’s say you sell that stock 2 years later for $15k and owe taxes at 15% on the $5k gain, do you consider that double taxes?
I agree on the opportunity cost as a costs as I’ve stated multiple times including in the post you are responding to, but I’d still argue the loss of a job risk is the bigger risk. ( 8-10% with high risk I’m equities or 4-5% with no risk is not that big of a difference adjusted for that risk, and depending on your other borrowing options may actually be higher return than expected equity returns)
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