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trident
Tennessee Fan
Member since Jul 2007
3559 posts

401K loan withdrawl

Can someone explain to me taking a loan against your 401K would be a good idea? I have heard that people take them and actually make more money on it when taking a loan but am skeptical.

I am not looking to take a loan, I am just curious.


notiger1997
Member since May 2009
26057 posts

re: 401K loan withdrawl
It's not a bad idea if you really need some money in a hurry. The interest rate right now for mine if I were to do it would be around 3.2%.


trident
Tennessee Fan
Member since Jul 2007
3559 posts

re: 401K loan withdrawl
Currently my interest rate is 1.5%

Would it be a dumb idea to take out a loan for home repairs?


ZereauxSum
LSU Fan
Lot 23E
Member since Nov 2008
10176 posts

re: 401K loan withdrawl
Mine is prime plus one, which makes it like 4 now I believe? Man my rate sucks!

You can make money on it if the value of your 401K declines durning the time your loan is out, because you've essentially "shielded" that portion from loss. Also, the interest you are paying goes into your 401K, so the account comes out "ahead".


trident
Tennessee Fan
Member since Jul 2007
3559 posts

re: 401K loan withdrawl
quote:

You can make money on it if the value of your 401K declines durning the time your loan is out, because you've essentially "shielded" that portion from loss. Also, the interest you are paying goes into your 401K, so the account comes out "ahead".


so you are paying yourself back the interest if you take out a loan?


ZereauxSum
LSU Fan
Lot 23E
Member since Nov 2008
10176 posts

re: 401K loan withdrawl
quote:

so you are paying yourself back the interest if you take out a loan?


Yup. But your payments will all be after tax. That's the drawback.


trident
Tennessee Fan
Member since Jul 2007
3559 posts

re: 401K loan withdrawl
quote:

But your payments will all be after tax. That's the drawback.


i gotcha. well that really sucks.


ZereauxSum
LSU Fan
Lot 23E
Member since Nov 2008
10176 posts

re: 401K loan withdrawl
Yeah, most of the time it's not a particularly good loan, which is why I was careful to say that the account come out ahead

But like someone said earlier, if you need a loan quick without a lot of hassle and no credit report impact, it's worth thinking about.


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Bayou Tiger
LSU Fan
The Woodlands, TX
Member since Nov 2003
3365 posts

re: 401K loan withdrawl
quote:

But your payments will all be after tax. That's the drawback.
Is there an alternative loan that you can pay back before tax? Some loans have deductible interest, but in this case you get to keep the interest for yourself (even better).

Three drawbacks:
- If you lose your job or leave the company, you have to pay back the balance of the loan or get hit with an early withdrawal penalty.
- Many employer plans allow only one loan at a time. So if you take out a loan to upgrade your house, you lose the ability to draw a loan if a situation comes up where you really need the money later.
- Payments are often deducted directly from your paycheck. That may or may not be an issue for somebody.

In the past I have taken a 401k loan to use for some investments and it worked out great. I liked the added liquidity and the idea that the interest was being paid to myself.


foshizzle
LSU Fan
Washington DC metro
Member since Mar 2008
32164 posts
Online

re: 401K loan withdrawl
quote:

You can make money on it if the value of your 401K declines durning the time your loan is out, because you've essentially "shielded" that portion from loss.


Of course it goes both ways, if the market suddenly goes up 100% then the portion of your 401 that is invested in the loan is "shielded" from the gain.


Bayou Tiger
LSU Fan
The Woodlands, TX
Member since Nov 2003
3365 posts

re: 401K loan withdrawl
And a simpler way to "shield" your 401k from a loss is to move some or all of it into a money market fund within the 401k.


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ZereauxSum
LSU Fan
Lot 23E
Member since Nov 2008
10176 posts

re: 401K loan withdrawl
quote:

Is there an alternative loan that you can pay back before tax? (even better).


No, but my point is that you basically are taxed twice on your 401k savings, once when you borrow it and again when you withdraw it.

Just didn't want to give the impression that its as simple as "I take the money out an put it back with interest".


ZereauxSum
LSU Fan
Lot 23E
Member since Nov 2008
10176 posts

re: 401K loan withdrawl
quote:

Of course it goes both ways, if the market suddenly goes up 100% then the portion of your 401 that is invested in the loan is "shielded" from the gain.


Absolutely. I proposed that scenario on response to the OPs question on how one might say they came out ahead by doing this.


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Bayou Tiger
LSU Fan
The Woodlands, TX
Member since Nov 2003
3365 posts

re: 401K loan withdrawl
quote:

No, but my point is that you basically are taxed twice on your 401k savings, once when you borrow it and again when you withdraw it.
I was not taxed on the pre-tax 401k contributions and was not taxed on the loan withdrawal. If paid back into the 401k, the only time these funds will be taxed is when they are ultimately withdrawn.

The catch is if you leave the company and do not pay back the balance of the loan, in which case you will be taxed on the unpaid portion including the early withdrawal penalty.

Maybe I missed something. Which funds are taxed twice?

I assume you are excluding the age-old double-taxation issue of corporations being taxed and then their shareholders being taxed again on the same profits.


ZereauxSum
LSU Fan
Lot 23E
Member since Nov 2008
10176 posts

re: 401K loan withdrawl
quote:

Maybe I missed something. Which funds are taxed twice?


Not directly taxed, but when you borrow against your 401k, you are basically taking out pretax dollars and replacing them with after tax dollars when you pay it back. Then when you withdraw for retirement, you pay taxes on it again.


JonTheTigerFan
LSU Fan
Central, LA
Member since Nov 2003
4938 posts
Online

re: 401K loan withdrawl
quote:

Of course it goes both ways, if the market suddenly goes up 100% then the portion of your 401 that is invested in the loan is "shielded" from the gain.


Our company 401k isn't setup that way. It's more like you're borrowing money with the 401k as collateral. You don't lose any gains you would have realized by taking a loan against it and also don't shield your 401k from losses as the market fluctuates. The only drawback I could see in ours is if you lost your job and had to pay it all back at once or take the loan value as a withdrawal that would be taxed and penalized.


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Bayou Tiger
LSU Fan
The Woodlands, TX
Member since Nov 2003
3365 posts

re: 401K loan withdrawl
quote:

Not directly taxed, but when you borrow against your 401k, you are basically taking out pretax dollars and replacing them with after tax dollars when you pay it back. Then when you withdraw for retirement, you pay taxes on it again.
I get what you are saying, since I used to see it the same way.

However, the key to understanding a 401k is to look at independently in its two distinct components.
1) The 401k is essentially investing in a fixed return fund at the loan's interest rate. So if you can do better this return with other funds in your 401k, you are giving up value. ETA: Apparently other plans work differently, but mine definitely deducts the loan from the investable 401k balance.
2) The cost of the loan can be compared against other borrowing options. The interest is not tax deductible, but is better in that you pay the interest to yourself. It is not collateralized in the exact sense, but you cannot skip payments if payroll-deducted, and there is the risk of a big tax hit if you leave the company and can't repay the balance.
This post was edited on 1/7 at 12:18 pm


ZereauxSum
LSU Fan
Lot 23E
Member since Nov 2008
10176 posts

re: 401K loan withdrawl
Yeah, that's true. Don't get me wrong, I think it can be a great loan. I've actually considered taking one out for a house purchase.

I guess it really just comes down to whether or not your 401k balance goes up or down.


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