(NA) loan against 401k ?

eman1200

eman1200

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anyone ever taken a loan out on your 401k? work offers this option, it's 5.5% but you pay that back to yourself. basically, other than the interest being taxed as income, its kinda sorta a free loan? any thoughts?
 
I've done it... pretty benign... course, didn't borrow much, paid it back in a couple months...
 
I do it pretty regularly, I try to take out the loan when the market is pretty high, if the the market declines it get to pay it back in cheaper dollars. Most people would love a guaranteed 5.5% return on their money.

Haven't been able to figure out the math to determine if I would have done better leaving the money in the 401K, but generally think I have done pretty well.

Brian
 
I did it once for $10Gs to buy some adjoining land, worked out great as I paid back myself w/ interest and the land appreciated. Win win!
 
The issue with it is that the funds that you're paying back with are double taxed:
Let's say you have $100,000 in your standard 401(k)
You borrow $10,000
Your 401(k) has $90,000 now, and you're paying back $500/month for 21 months (accounting for interest of $500)
When you look at your check, that $500/month is after tax money, and your check goes down by $500
When you withdraw the money at retirement, you are taxed again on it.

Other issues against this:
Loss of appreciation on the missing funds
If you leave your job, or if your job leaves you, 100% of the remaining funds are due within 30 days.

(Truth in advice: I've done it twice ($10K each), and had I not done it, I'd be up over $60,000 vs. the $20,000 borrowed)
 
JCranford said:
Too much risk. If you leave your job (or it leaves you) I believe the loan becomes immediately due.
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not the way mine works, which is one of the reasons I use it. If I my job leaves me I can opt to continue the payments or stop payment and take the balance as an early withdrawal on the 401k, albeit with a pretty hefty penalty. But if I don't have a job, the penalty might be a better option.

Brian
 
Jeffythequick said:
The issue with it is that the funds that you're paying back with are double taxed:
Let's say you have $100,000 in your standard 401(k)
You borrow $10,000
Your 401(k) has $90,000 now, and you're paying back $500/month for 21 months (accounting for interest of $500)
When you look at your check, that $500/month is after tax money, and your check goes down by $500
When you withdraw the money at retirement, you are taxed again on it.

Other issues against this:
Loss of appreciation on the missing funds
If you leave your job, or if your job leaves you, 100% of the remaining funds are due within 30 days.

(Truth in advice: I've done it twice ($10K each), and had I not done it, I'd be up over $60,000 vs. the $20,000 borrowed)
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Double taxed? That seems like some funny math to me. By the time you have paid the loan off you will have earned $110,000. You will have payed taxes on the $10,000 you put back in, but you only have $100,000 in the 401K, since you borrowed the other $10,000 and hadn't payed any taxes on it at that point. When you retire you will still only be paying taxes the $100,000 still in the 401k.



Brian
 
it is definitely double taxed and work def wants full payment if I leave or if I'm axed.
 
I'm pretty sure that you have only a limited time (two months) to repay the money on termination or else it WILL be considered a taxable (with 10%) penalty withdrawal.

I agree with Brian, it's not double taxed.
 
flyingron said:
I'm pretty sure that you have only a limited time (two months) to repay the money on termination or else it WILL be considered a taxable (with 10%) penalty withdrawal.

I agree with Brian, it's not double taxed.
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you're wrong, it is double taxed. the lender even told me that. 1) interest taxed as income, 2) 401k taxed as normal when retired and taking money out of it.
 
Ah the INTEREST. In that case you are right. The principal is not double taxed. However, you pay your tax rate (lets say it's 33% both times) twice for 66% If you had a non 401(k) loan you'd be taxed when you earned the money and then you'd give over the entire amount to the lender as if you were taxed 133%. One hopes that your tax bracket at retirement is less than that.
 
eman1200 said:
you're wrong, it is double taxed. the lender even told me that. 1) interest taxed as income, 2) 401k taxed as normal when retired and taking money out of it.
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You should probably find a new lender. The interest you pay into your 401(k) is not taxed as income.
 
Gerhardt said:
You should probably find a new lender. The interest you pay into your 401(k) is not taxed as income.
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Yeah, it will when it is eventually withdrawn and it likely came from a taxable source (his income) so yes, he gets "taxed" twice. But with a normal loan, he never sees the repaid interest again, so it's still a win even if he has to pay tax on it when withdrawn.

It doesn't make anysense to pull money out of the 401k unless you'd have to borrow it from elsewhere if you didn't.
 
I've done it twice, both times to remodel a house. When I retire next year (at 60), my employer will send me a 1099 stating that the remainder of the loan is income to be taxed.
 
brcase said:
Double taxed? That seems like some funny math to me. By the time you have paid the loan off you will have earned $110,000. You will have payed taxes on the $10,000 you put back in, but you only have $100,000 in the 401K, since you borrowed the other $10,000 and hadn't payed any taxes on it at that point. When you retire you will still only be paying taxes the $100,000 still in the 401k.



Brian
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Yeah, as others have said, that $10,000 that you borrowed and re-paid (plus the interest) is double taxed. The principal that you left in there (in the case I laid out, the $90,000) is only taxed once.
 
eman1200 said:
you're wrong, it is double taxed. the lender even told me that. 1) interest taxed as income, 2) 401k taxed as normal when retired and taking money out of it.
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Had you taken the loan anywhere else you'd have paid it back with taxed income and probably a higher interest rate. Only hope for an interest/tax free loan from mom and dad.
 
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Jeffythequick said:
Yeah, as others have said, that $10,000 that you borrowed and re-paid (plus the interest) is double taxed. The principal that you left in there (in the case I laid out, the $90,000) is only taxed once.
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I'm really not understanding the double-taxed logic. The fact that you're paying back your 401k with after tax $ has nothing to do with it. If you borrowed $10k from your aunt Maude, would it be an issue when you paid her back with after tax $? The 401k you're borrowing from is almost like a third party in this regard.
 
Gerhardt said:
You should probably find a new lender. The interest you pay into your 401(k) is not taxed as income.
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I think what he means is that the interest that you pay into a 401(k) loan is after tax dollars on your paycheck, so it has already been taxed once, and then, when you withdraw it after retirement, it is taxed again as income.

An example (and I hope I get it right this time):
You borrow $10,000 from your Standard (not Roth) 401(k), spend it on new avionics, and pay the loan back with your next paycheck (interest of $1.64)
(because you're making $166,625K/year and you live in WA, FL, TX, or some other state with no income tax):
Your paycheck (use the monthly column, this is from
http://us.icalculator.info ):
Gross Pay: $ 13885.42
Exemptions: $ 858.33
Taxable Income: $13,027.08
Federal Inc. Tax: $ 3070.19
FICA $ 612.25
Medicare: $ 201.34
Net Pay: $ 10,001.64 (Used to pay back 401(k) loan. You earned $13,885.42 to pay back $10,001.64.

So, you earned $13,885.42 (gross pay), but only put $10,001.64 (taking the take home pay and paying back the loan, so your check will be $0) back into your 401(k).

That loan cost you $3883.78 in taxes when you repaid it. (For those of us that don't make $166,625, that number will be less, but hey, you're on an aviation website, so it won't be much less.)

The next month, you retire, and take $10,001.64 (gross, the amount you just paid back) out of your 401(k) (yes, you're over 59 1/2):

Gross Pay: $10,001.64 (your monthly gross from the 401(k)
Exemptions: $ 858.33
Fed. Inc. Tax: $ 1,982.73
FICA $ 612.25
Medicare: $ 145.02
Take Home Pay $ 7,261.64 Taking out the amount you just paid back nets you about $2800 less, due to the taxes paid on it as ordinary income.

That's why I advise against it. Your repayment and interest is double taxed. It gets worse in states that tax income as well. When looking at these numbers, I'm not sure what a "circumstance exemption" is, but the point I'm making is that your repayment and your interest paid on the loan is after tax money at repayment, and taxed again as regular income at retirement withdrawal.
 
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If, during the term of the loan the market goes up 15% and you've been paying 5.5% you've lost 9.5% on that money.
 
OK, there are two people, each person makes $10,250 a year (after taxes) and has saved $10,000 in a 401(k).

Person A. Leaves it there and earns 5% interest on it. Separately, he borrows $10,000 at 5% interest. He uses all his income for that year to repay the loan plus interest.

Person B. Borrows the entire balance of his 401k at an interest rate of 5%. He uses all his income for the year to repay his 401 loan.

They both end up in the exact same spot. How did person B get double taxed?
 
Sam D said:
I'm really not understanding the double-taxed logic. The fact that you're paying back your 401k with after tax $ has nothing to do with it. If you borrowed $10k from your aunt Maude, would it be an issue when you paid her back with after tax $? The 401k you're borrowing from is almost like a third party in this regard.
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if u took out a 'normal' loan from a bank, THEY would charge YOU interest. at tax time, I believe you could deduct that tax paid. in THIS case the interest you are paying on the loan is being paid BACK TO YOU, so it is considered income, and therefore taxed. hope my Finance101 explanation made sense (and was accurate, I think it was).

EDIT: and further to this explanation, basically, YOU are lending YOURSELF money. this is where the difference is.
 
eman1200 said:
if u took out a 'normal' loan from a bank, THEY would charge YOU interest. at tax time, I believe you could deduct that tax paid. in THISs case the interest you are paying on the loan is being paid BACK TO YOU, so it is considered income, and therefore taxed. hope my Finance101 explanation made sense (and was accurate, I think it was).
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Ah, now you're talking about deductibility of expenses (interest payments) which is different than taxing income twice. Your borrowing would basically need to be a mortgage loan or HELOC to be deductible. No go on car loans, plane loans, credit card loans, monkey loans, etc.
 
Sam D said:
OK, there are two people, each person makes $10,250 a year (after taxes) and has saved $10,000 in a 401(k).

Person A. Leaves it there and earns 5% interest on it. Separately, he borrows $10,000 at 5% interest. He uses all his income for that year to repay the loan plus interest.

Person B. Borrows the entire balance of his 401k at an interest rate of 5%. He uses all his income for the year to repay his 401 loan.

They both end up in the exact same spot. How did person B get double taxed?
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Person B paid taxes on the $10,250 when they earned it (so they actually have to earn about $11,500 to pay back $10,250, being taxed $1000 at earning) and will get taxed again on that money paid back into the 401(k) at retirement when they money is taken out.

I re-edited my post above that has the actual numbers for a loan of $10K.
 
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Sam D said:
Ah, now you're talking about deductibility of expenses (interest payments) which is different than taxing income twice. Your borrowing would basically need to be a mortgage loan or HELOC to be deductible. No go on car loans, plane loans, credit card loans, monkey loans, etc.
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ok. it's been a long long time since I took out any kind of loan, so I believe you. however, it still doesn't change THIS PARTICULAR type of loan. 'I' am loaning 'ME' money and making money off the loan (whether that money could have been more or less, like some people mentioned, isn't the point of this conversation). I am taxed on the income, then I am taxed eventually when the money is taken out of the 401k to pay for hookers and blow in retirement which, whether I'm double taxed or not, WILL happen.
 
Jeffythequick said:
Person B paid taxes on the $10,250 when they earned it (so they actually have to earn about $11,500 to pay back $10,250, being taxed $1000 at earning) and will get taxed again on that money paid back into the 401(k) at retirement when they money is taken out.
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What GlennAB1 said. Both Person A and B pay the exact same amount of taxes.
 
Sam D said:
What GlennAB1 said. Both Person A and B pay the exact same amount of taxes.
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Glenn didn't say anything about taxes, he said the two people paid the same amount for the loan, which is true. but person A paid 5% INTEREST to the bank, while person B paid 5% interest TO HIMSELF.
 
eman1200 said:
Glenn didn't say anything about taxes, he said the two people paid the same amount for the loan, which is true. but person A paid 5% INTEREST to the bank, while person B paid 5% interest TO HIMSELF.
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Sorry, I was echoing what Glenn was saying in that any loan is paid with after tax dollars. And that a loan was a loan. Further, I was clarifying that, in my example, there was no difference between the two scenarios.

P.S. Didn't his avatar used to be a teddy bear. Can you just change like that?
 
Sam D said:
OK, there are two people, each person makes $10,250 a year (after taxes) and has saved $10,000 in a 401(k).

Person A. Leaves it there and earns 5% interest on it. Separately, he borrows $10,000 at 5% interest. He uses all his income for that year to repay the loan plus interest.
Person A. is paying OFF a loan with regular income: after tax dollars. Closed end loan; he is done with it. End of story.

Person B. Borrows the entire balance of his 401k at an interest rate of 5%. He uses all his income for the year to repay his 401 loan.
Person B. is PAYING BACK the money he took from his 401k with after tax dollars. And then when he retires he will pay tax (again) on that repaid money when he withdraws it.

They both end up in the exact same spot. How did person B get double taxed?
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That's not how I understand it (see above).
 
I'm no 401k expert, though I was fortunate to start doing it early, but I gotta say this is the only place I've ever heard of anyone espousing borrowing from a 401(k) as a reasonable strategy. Not that that's bad in and of itself, but I've always considered it to be somewhat of a forbearance or hardship loan and I believe my employer discourages using it for any other means.
 
iflyvfr said:
I'm no 401k expert, though I was fortunate to start doing it early, but I gotta say this is the only place I've ever heard of anyone espousing borrowing from a 401(k) as a reasonable strategy. Not that that's bad in and of itself, but I've always considered it to be somewhat of a forbearance or hardship loan and I believe my employer discourages using it for any other means.
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so aside from the difference in opinion about the tax portion, this is more what I was looking for, although you don't really state why. if you consider it a hardship loan, why do you? that's what I was looking for, why is it a good or bad idea to do. keep in mind, I wouldn't be taking money out of my 401k, which would come with severe penalties of, oh, I don't remember, 25% penalty or something stupid like that. but it sounds like you already know that.
 
eman1200 said:
so aside from the difference in opinion about the tax portion, this is more what I was looking for, although you don't really state why. if you consider it a hardship loan, why do you? that's what I was looking for, why is it a good or bad idea to do. keep in mind, I wouldn't be taking money out of my 401k, which would come with severe penalties of, oh, I don't remember, 25% penalty or something stupid like that. but it sounds like you already know that.
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I don't state why because I don't know all the negative ramifications of doing so, I'm more or less repeating what I've always been told "Don't do it. Bad Idea, double taxed."

I'm sorry I can't answer your question, but I'm interested if someone with firsthand knowledge can say whether it is or is not a good idea. Something like the future value of current money is being discounted, or you're missing out on buying cheap with the possibility of missing gains on the rebound from this last (lousy) quarter of earnings.
 
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