Borrowing from your 401K | TigerDroppings.com

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LessofLes
LSU Fan
Member since Sep 2010
1135 posts

Borrowing from your 401K


I worked with a guy who borrowed several times from his 401K for various reasons. Most of it was spent building a home he had to sell because of a divorce. Also, he no longer works for the company.

He led a very overextended life and doubt that he's in a position to pay those loans back. What's the penalty if he's not paying back that money? I'm sure the company is obligated to notify the feds at some point. Will he just forced to show the borrowed money as income at some point in order to have to pay income tax on it?

I'm just curious to how that works.







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Duckman13
LSU Fan
Tiger Stadium
Member since Dec 2006
2820 posts

re: Borrowing from your 401K


quote:

worked with a guy


Ok






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JPLSU1981
LSU Fan
Baton Rouge
Member since Oct 2005
17291 posts

re: Borrowing from your 401K


Yes, if you don't pay a 401k loan back, it gets treated as a 401k distribution which becomes fully taxable as ordinary income (+10% penalty if you are under 59.5 years old).

At that point, you no longer "owe" the money back. Loan is done.

Of course, on the other hand, if you pay the loan back as scheduled, it's like nothing ever happenned tax-wise.







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ZereauxSum
LSU Fan
Lot 23E
Member since Nov 2008
8486 posts
 Online 

re: Borrowing from your 401K


quote:

Ok




To answer the question, the former company would most likely would have demanded payment in full shortly after his termination.

If he couldn't pay, they would take it out of his 401K. This would be treated as an early withdrawal by the IRS, so he would have to pay taxes and a 10% penalty.






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LessofLes
LSU Fan
Member since Sep 2010
1135 posts

re: Borrowing from your 401K


Last I checked I'm not divorced or never built a house.

I'm considering borrowing against my 401k for a capital injection into a business that I own. The idea of borrowing from my 401K led me to thinking about him.

Sorry to disappoint.






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ATL TGR
LSU Fan
Houston
Member since Apr 2008
2878 posts

re: Borrowing from your 401K


quote:

I'm considering borrowing against my 401k








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wegotdatwood
Arkansas Fan
Member since Aug 2009
17094 posts

re: Borrowing from your 401K


God, so glad I'm not a dip shite to do that with a retirement account.





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geauxbears08
LSU Fan
Houston, TX
Member since Jun 2011
54 posts

re: Borrowing from your 401K


quote:

Of course, on the other hand, if you pay the loan back as scheduled, it's like nothing ever happenned tax-wise.


Not exactly. You paid back your loan with after-tax dollars. That's a huge penalty.






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Sigma
Michigan State Fan
Fairhope, AL
Member since Dec 2005
1940 posts

re: Borrowing from your 401K


http://www.tigerdroppings.com/rant/display.aspx?p=42346069





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LessofLes
LSU Fan
Member since Sep 2010
1135 posts

re: Borrowing from your 401K


quote:

God, so glad I'm not a dip shite to do that with a retirement account.


It's risk/reward given my current opportunity. Also, it's a very small fraction of my overall balance.

I wouldn't call anyone a "dipshit" until you've walked a mile in their shoes or experienced their current situation. Keep that shite on the OT.






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ZereauxSum
LSU Fan
Lot 23E
Member since Nov 2008
8486 posts
 Online 

re: Borrowing from your 401K


It could potentially be a good move, just go into it understanding everything that will or potentially happen.

So plans have a rule where you are not allowed to make contributions until a loan is paid back.

Also, if your employment situation is shaky it might not be smart. The worse thing that can happen is you get terminated and the IRS hammers you.

Also keep in mind that you are essentially paying taxes on the money twice...once when you pay it back with after tax dollars and again after you retire.

Just make sure you have enough info to make an objective decision.






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LessofLes
LSU Fan
Member since Sep 2010
1135 posts

re: Borrowing from your 401K


Thanks for the info.

Our plan allows for continued contributions while loans are active and there is no penalty for paying it back sooner than terms. I understand paying it back with after tax money (I'd pay a business loan back with the same after tax money).

I get that I'll pay tax on it again when I use it in retirement and that I lose potential market gains while the balance is in my hands and not in funds. However, you have to pay to play at some point so that's the penalty I'll have to accept.

Employment is secure. The loan could potentially be for 18 months and I could repay the balance with bonus money EOY 2014.







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LessofLes
LSU Fan
Member since Sep 2010
1135 posts

re: Borrowing from your 401K


quote:

Sigma


Thanks for the link to the read.






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ZereauxSum
LSU Fan
Lot 23E
Member since Nov 2008
8486 posts
 Online 

re: Borrowing from your 401K


It sounds like you're going into it with your eyes open. My plan doesn't prevent contributions when a loan is outstanding, but it does have restrictions on early payments while still employed. Pretty cool that yours doesn't.

Depending on the purpose, I'd consider doing it myself. I've come to believe that personal finances are never a black and white issue and there are no universally good and bad actions.

You're right about the tax implications (you're paying it back with after tax dollars regardless of who you borrow from) but just wanted to point that out. Some people don't want to forfeit the tax advantages of their retirement accounts.

Good luck!






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El Josey Wales
LSU Fan
Greater Geismar
Member since Nov 2007
22710 posts

re: Borrowing from your 401K


quote:

wouldn't call anyone a "dipshit" until you've walked a mile in their shoes or experienced their current situation. Keep that shite on the OT


He's the new czar of the Money Board.






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Golfer
LSU Fan
Coral Bay, St. John, USVI
Member since Nov 2005
56860 posts

re: Borrowing from your 401K


quote:

He's the new czar of the Money Board.



He seems like a nice guy, but by virtue of having his education covered by the military and living in an area with a low cost of living, he's benefiting from a dual-income household.






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El Josey Wales
LSU Fan
Greater Geismar
Member since Nov 2007
22710 posts

re: Borrowing from your 401K


He also couldn't figure out his deduction form at work yet he calls this guy a dip shite.

There's no reason for name calling here.






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JPLSU1981
LSU Fan
Baton Rouge
Member since Oct 2005
17291 posts

re: Borrowing from your 401K


Not advising everyone go out and take a 401k loan, but the 401k loan "double taxation" is a myth. Probably the easiest way to explain it is this way: You take out a $10,000 401k loan, you put that money in your pocket, two months later you pay the loan back with that exact same $10,000 you've had in your pocket the whole time.....your taxes are not affected one bit, obviously.


http://www.federalreserve.gov/pubs/feds/2008/200842/200842pap.pdf

LINK

LINK

LINK

LINK

quote:

3.2 Tax Considerations
401(k) loans are sometimes described as facing double taxation, because (unlike regular
contributions) loan payments are made with after-tax dollars, and then account assets
are taxed again upon withdrawal in retirement.11 This argument turns out to be wrong,
because in practice, the tax treatment of 401(k) loans does little to alter the tax-preferred,
“consumption-tax” treatment of retirement accounts. To see why, consider the following
illustration of the consequences of taking a 401(k) loan, from a consumption-tax perspective.
Traditional retirement accounts implement consumption-tax principles (i.e., that wages
should be taxed when they are consumed rather than when they are earned) by offering
a tax deduction for wages contributed to the account, and then taxing withdrawals of
contributions and their earnings as ordinary income. Since the idea of a consumption tax
is to tax consumption rather than saving, “traditional” consumption tax treatment of a
401(k) loan would be to tax the loan when it’s taken, but not the repayments. In the real
world, the situation is reversed: loan proceeds are not taxed, but no deduction is offered
for repayments. Thus the timing of tax deductions and payments for an account with
a loan is exactly the same as one without a loan—a deduction is offered for the initial
contribution, withdrawals in retirement are fully taxed, and no other deductions are offered
in the interim.12
What about the charge that loan payments are “double-taxed”, once upon repayment
and again upon withdrawal in retirement? This turns out to be a mirage: the loan principal
is clearly taxed only once—when it is repaid with after-tax dollars. Since loan proceeds
are not taxed when distributed, the tax on repayment is really just a delayed tax on the
consumption of the loan proceeds. The “second” tax, upon withdrawal in retirement, is tax
on the consumption of the repayments in retirement. Thus each dollar of consumption is
taxed just once.


It's complex to think about in your head, so I understand why some people think double taxation, but here is an example that I find easier to understand:

quote:

Suze insists that taking a 401k loan results in double-taxation of the principal, as one repays tax-exempt money with after-tax money.
But she is using flawed reasoning, and here is why: MONEY is FUNGIBLE.
Do the following thought experiment:
You take out $20k from your savings account (after-tax $$) to buy a car and place it in an envelope.
Then you take out a $20k loan from your 401k, and put that into an identical envelope.
You go buy the car and pay for it with the cash from one of the envelopes, having forgotten which was which.
You then repay the loan with the contents of the OTHER envelope.
NOW, did you repay the loan with pre-tax or post-tax money?
You would never know as there is NO DIFFERENCE.





This post was edited on 7/10 at 4:13 pm


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LSUAfro
LSU Fan
Baton Rouge
Member since Aug 2005
10359 posts

re: Borrowing from your 401K


quote:

You take out a $10,000 401k loan, you put that money in your pocket, two months later you pay the loan back with that exact same $10,000 you've had in your pocket the whole time


Why would you take out a loan to put it in your pocket?






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JPLSU1981
LSU Fan
Baton Rouge
Member since Oct 2005
17291 posts

re: Borrowing from your 401K


Of course you wouldn't, I just find that the easiest way for someone to understand that the commonly used "401k double taxation" is a myth.

Bottom line: There are certainly negatives to 401k loans (the biggest being if you don't pay it back it becoming taxable plus possible penalty), but double taxation is not a negative for a 401k loan. Double taxation should not be a consideration in taking a 401k loan.



This post was edited on 7/10 at 4:17 pm


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