Take out a loan on your 401K?

[ag2]

I'm starting a new thread to respond to a comment I read on another thread.

<quote>Borrow against your 401k, then pay yourself back. I'm not sure how this works outside of New York, but I know a bunch of people who borrow against their 401k to buy cars, then they pay back the money into their own retirement which they get later on.</quote>

I know lots of people who have done this and it isn't always bad, but I think people need to think through this completely before borrowing from your own 401K.

I am not a financial advisor!  But I had this concern.

The money I put into my 401K is currently tax sheltered.  Contributions are taken out of my paycheck before tax.   It will be taxed when I withdraw it.  Let's say that I borrow against my 401K.  I assume that I have to pay back the loan with AFTER tax money.  That chunk of money is going to be taxed AGAIN when I withdraw it.  Am I wrong?  So if I borrow $5,000 from my 401K, I will pay tax on that $5,000 as I pay it back.  Then when I withdraw this money in my golden years, I am quite certain that the guberment is going to make sure that $5,000 is taxed again before I get to use it.

I could be mistaken and would really appreciate it if a financial advisor could chime in and correct me if I am wrong.  I think many people would like to hear how this works.  Perhaps Jack could discuss this in a podcast?

[JGreene]

For what its worth..

We had to borrow about $3K due to a fire and issues with the insurance company.  We where able to pay it back within 90 days so we shouldn't have had to pay taxes on it.  There's a 5498 form ( I could have that number wrong) that accompanies the check to return the cash.  It is very important that it is marked as a ROLL OVER and not a PURCHASE.   We're having to jump through hoops to get this problem corrected.

The taxes and fees would be around 50%, a little more I believe. 

[PrepperJim]

I am also not a tax advisor, but here is my understanding of taking a loan from your 401(k).

-You withdraw a certain amount say $10,000 and do not pay taxes on it.
-You pay back over a period of time say 36 months with interest (for example, 5%).
-The extra interest you pay back into the 401(k) is then taxable when you turn 59 1/2 and start taking withdrawals. Thus, you increase your future tax bill by this process.
-If you don't pay it back, you have to pay a withdrawal penalty plus regular income tax. This can be a 50% hit.
-If you leave that place of employment, you have to pay it back or pay the penalty and income tax.

To me, this is just another form of debt to be avoided. There are too many traps (loss of job, wanting to change job but cannot, inability to make the payment etc etc) that can get you over 36 months. In other words do not do it under any circumstance . Find another way!

[Saint]

Prepper Jim just stole my answers!
basically ditto - Dave Ramsey deals/speaks about this a lot on his show: the plan is workable from a pure numbers perspective, but then there's the added factor of "risk"
if you're a natural risk taker and subscribe to the "use other people's money" approach to leverage, then this "plan" probably works for you (for your disposition that is), but if you're more risk averse, more conservative and/or just aren't so sure about the security of your job (or company) its not the financial scheme to get involved with.
another similar, slightly less risky option is the home equity loan - same basic concept: you take a "loan" from yourself for a thing, then pay yourself back - and get to write off interest paid.
I'm not into this either, but in the first case if you lose your job, you have to pay that 401k loan back pronto, in the second case, if you lose your job you're still up poop-creek (with a mortgage and HELOC) but the house was at risk anyway in the job loss, so there's no apparent added pain.

[Crash]

I closed mine and rolled the money into precious metals. In a SHTF scenario, 401Ks will disappear. Mine was losing money anyway, so I re-invested. Silver and gold can be written off as a 401K too, so I lost nothing and have actually gained.

[ag2]

Good on you.  I did that to a large portion of mine also.

[JGreene]

I closed mine and rolled the money into precious metals. In a SHTF scenario, 401Ks will disappear. Mine was losing money anyway, so I re-invested. Silver and gold can be written off as a 401K too, so I lost nothing and have actually gained.

How did you roll it over into physical gold and silver?
I believe you can roll it over into a silver/gold paper fund (which will also disappear)  otherwise a cash in results in penalties and taxes.

Just curious, I'd like to do this with a portion, but I didn't know it was possible. (without penalty)

[chrisdfw]

The taxes are not the reason not to borrow.

When you take the loan, you pay no tax, pretty much the case for all loans

Yougive up growth on the amount borrowed (the would have been taxed when withdrawn)

Instead of investment returns on the money you pay interest which is taxed when withdrawnjust like the earnings would have been.

Whether it is good has nothing to do with taxes if you plan to stay on your job( if you lose your job all bets are off)

To decide whether it is a good idea, compare the interest savings (what you would pay to borrow from non401k source minus 401k borrowing cost) to the forgone invesment earnings (excpected earnings minus 401 loan interest)

If you save more in interest than you give up in earnings its a good deal

[Cooter Brown]

How did you roll it over into physical gold and silver?
...
Just curious, I'd like to do this with a portion, but I didn't know it was possible. (without penalty)

http://www.apmex.com/GoldinIRA/Default.aspx?gclid=COCK-uWYiKgCFYXc4AodsClPrw

[ag2]

I think a few people have misunderstood me with regard to paying taxes.  Let's see if I can provide a better explanation.

Take a look at your last paystub or paycheck.  How much did the government take out before your employer wrote your check?  10%?  15%? 20%

Let's say you are thinking about taking out a $2,000 loan on your 401K.  That is tax sheltered money.  That means that you earned $2,000 to make $2,000.  That's not the case with your take home pay every month.  You have to earn more like $2,300 to take home $2,000.

So if you take out a loan for $2,000 (money that has not yet been taxed), you have to use your take home pay (money that has been taxed) to pay off your loan.  So realistically, you have to earn about $2,300 or so to take home $2,000 to pay back that loan.  YMMV

Then when you turn 65 and begin withdrawing that money, guess what?  The government doesn't care that you already paid tax on $2,000 of your 401k.  They will tax it again.

I hope this helps.

[chrisdfw]

Let's say you are thinking about taking out a $2,000 loan on your 401K.  That is tax sheltered money.  That means that you earned $2,000 to make $2,000.  That's not the case with your take home pay every month.  You have to earn more like $2,300 to take home $2,000.

That is correct, however that doesn't change anything.... if you take a 2000 loan from the credit union, you will have to pay that off with after tax money, so you will need to earn more like 2300 to take home 2000 to pay back the credit union.

When you borrow you get tax free money, you don't then get tax free money again when you pay it off. This is the same wherever you borrow money.

So it still comes down to which is greater:

forgone investment earnings - interest paid to 401k   
- or -
interest paid to outside lender - interest paid to 401k

if you save more than you give up, use 401k, otherwise borrow from the third party

Of course this assumes you plan to borrow and that you plan to repay the loan. If you don't plan to repay then borrow from the outside lender! kidding... sort of

[ag2]

Chris,

You are spot on.  Many folks can, but do not, pay off their college loans as quickly as they could because their money is earning more interest than the low interested rate they have on their tuition loan.

Because I have personally seen many people get so thrilled about borrowing against their 401K, I wanted to point out that it isn't really the deal they sometimes think they are getting.

I also wanted to point out just another of the many ways that the gubberment steals from us.  I believe in paying my share of taxes, but paying twice on the same chunk of money.....just irks me.

[chrisdfw]

I just thought of something that ag2 said and made me think

Any time we go into debt we really should consider what it is going to take to pay it back.

I used to listen to Dave Ramsey a lot, and he would talk about how someone making 100,000 could live on 50,000 and pay back 50,000 of debt in a year.
I am all for getting out of debt, but lets say you are a real person who pays taxes, makes 100,000 a year and wants to live on 50,000. You pay social security taxes of approximately 7500 on your 100,000 and federal income taxes of approximately 5 - 20 thousand, lets say 10,000 just to be conservative, lets assume you live in TX or other state with no income tax.
100,000 - 7500 - 10000 = 82,500
payroll dedeuctions for insurance, etc, probably no less than 300 a month for family coverage, or about 4000 a year. 82,500 - 4000 = 78,500

If you live on 50,000 you have 28,500 to pay off debt, a far cry from 50,000 and I am being conservative, my insurance and other payroll deductions are about 1000 per month (really good insurance but expensive) for my new job, and still almost 800 at my current job.

So even if you think you are making good money, its going to take a long time to pay off debt when you consider taxes. When my salary was approximatly 72000 a year 6000 a month, I took home a little less than 4000 when you consider payroll deductions and taxes. as your income goes up your tax rate goes up.

DON'T GO INTO DEBT. it costs you more than you think.

[nnicolasD]

Allowing loans within a 401k plan is allowed by law. However, just because you can obtain a loan from your plan doesn't mean it is always the best idea. You have to consider that there are cons in taking such action. More and more people opt to take out loans, but most of them have trouble paying them back once they take from their retirement funds. Read the article: 401(k) loan defaults.

[micoE]

When it comes to retirement, you want to make sure that you have enough cash for unexpected financial or medical emergency. This is very common for every retiree. You may have savings for your retirement, but it should never be touched. You can just get a short term loan rather than taking out of your retirement.