Author Topic: Need some quick advice...  (Read 6676 times)

Offline Tyler Durden

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Need some quick advice...
« on: March 01, 2014, 02:35:55 PM »
Once again, I need input from the folks at the TSP forum.  The question:  Liquidate 401k or borrow from relatives? 
The background:  We are in the process of a short sale for our house back in MN ( we recently moved to MT for a new job).  We had an 80/20 mortgage and the junior lender agreed to a settlement that involves $10,000 up front.  I don't have quick access to 10k.  I have about 2k saved up that I can use, and about 13k in a 401k.  I was planning on cashing out the 401k and using my savings for the 10k up front cost.  My mother-in-law told my wife we could borrow 10k from her, and my parents also offered to help.  The problem is that my parents are retired and not very well off financially, so I don't want to borrow their money, and my MIL is the type that would hold that favor over our heads for the rest of her life, and I don't want her to be able to say she helped us. 

Swallow my pride and ask relatives, or cash out the 401k?  I'm heavily leaning toward cashing out the 401k.  I haven't needed financial help from family since I moved out and I really don't want to start now.  Strictly a pride thing.

Offline TexasGirl

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Re: Need some quick advice...
« Reply #1 on: March 01, 2014, 02:45:03 PM »
Generally, you will have a significant penalty for liquidating the 401K.  If you have a short term plan for paying back the 10K, it might be better to take the MIL penalty.

~TG

Online David in MN

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Re: Need some quick advice...
« Reply #2 on: March 01, 2014, 02:57:46 PM »
The penalties on a 401k are a nightmare. I'd avoid if possible. Sorry about the tough spot.

Online FreeLancer

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Re: Need some quick advice...
« Reply #3 on: March 01, 2014, 03:28:31 PM »
I'd hate for you to lose up to half of your 401k if you cash out, plus there's a good chance that you'll be glad that you have that money some day when you've decided you don't want to work anymore. 

Obviously everybody's family dynamics are different, but I'd probably take the family loan.  However, structure it in a very business-like manner so it can't be construed as a hand-out.  Write up a payment agreement with interest so you both benefit.  My wife and I consolidated our student loans in the late '90s with a grandparent, split the difference on the interest we were paying vs what they could get on a CD, never missed a payment, and actually paid it off a couple years early.  It was a win-win for everybody, which is really the secret for any good business deal, and they raved about how we were the only family who ever paid them back as agreed. 

Offline inconel710

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Re: Need some quick advice...
« Reply #4 on: March 01, 2014, 04:06:13 PM »
Between your tax rate and the 10% penalty, the IRS is going to take 1/3 or more of your 401K money (depending on your income).   I'm going to assume that the short-sale situation is keeping you from getting the money as a signature loan at the bank.  Based on that, FreeLancer's advice is probably as good as it gets.  Write up a contract with reasonable terms and get everyone's signature on it.  After it's done, you can always put the contract back in the MIL's face and point out that she got a reasonable return on her money when she tries to send you on a guilt trip.

BTW - I'm no CPA, but I think your MIL can NOT set the interest rate at zero.  IRS considers that a gift.  You'll have to pay her back a "reasonable" interest rate.  Use the prime rate or the current 30yr mortgage rate, anything you (and the MIL) can defend as a benchmark for "reasonable".  Ten thousand is well below where the IRS starts charging gift tax, but it's something to be aware of if an auditor comes knocking.  MIL will have to report the interest as income as well to keep everything above board.  One more reason to hate the IRS.

Offline RitaRose1945

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Re: Need some quick advice...
« Reply #5 on: March 01, 2014, 04:57:08 PM »
You'll have to pay her back a "reasonable" interest rate.  Use the prime rate or the current 30yr mortgage rate, anything you (and the MIL) can defend as a benchmark for "reasonable".  Ten thousand is well below where the IRS starts charging gift tax, but it's something to be aware of if an auditor comes knocking.  MIL will have to report the interest as income as well to keep everything above board.  One more reason to hate the IRS.

IRS or not, this is a good idea anyway.  It makes it so there's less "look what I did for you" when you can counter with the fact that she made money on it.  Life is a lot more civilized when things are mutually beneficial and not one sided.

nelson96

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Re: Need some quick advice...
« Reply #6 on: March 01, 2014, 05:05:30 PM »
On the last remodel we did I took a loan out on my 401K (in my experience this is something most offer).  The cool thing is that the low interest you pay is to yourself (it goes back in to your 401K).  The only drawback is that you aren't earning money on the $$ you took out (obviously).

Offline flippydidit

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Re: Need some quick advice...
« Reply #7 on: March 01, 2014, 06:14:37 PM »
I would second Nelson's advice about taking a loan on your 401k.  You and your retirement account are really the only involved parties.  No one else needs to know about your finances, and you aren't liquidating the account permanently.  No penalties and no tax.  Just a thought.

Online FreeLancer

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Re: Need some quick advice...
« Reply #8 on: March 01, 2014, 07:03:00 PM »
It's my understanding that a 401k cash out option is only available to employees who have separated from the employer who sponsors the 401k, and that 401k loans are only an option if you are still working for the employer.  Also, any outstanding 401k loan balance is immediately repayable if the employer is separated from employment. 

My guess is the 401k loan option isn't available if the OP is talking about liquidation, otherwise, I'd agree it would be a reasonable route to pursue.

Offline ag2

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Re: Need some quick advice...
« Reply #9 on: March 01, 2014, 07:15:01 PM »
IMO, neither option is great.  My advice is to wait until you have the money.  You should have spare $$ for the emergencies that arise in these situations.  There WILL be surprises. Prepare to beat your head against the wall after conversations with banks, no matter how many questions you ask and preparations you make.

Keep in mind, if you take out a "loan" on your 401K, the money you have to earn to "pay yourself back" is POST TAX.  Most folks overlook that fact.  Keep in mind it is taxed again when you retire.  So you REALLY lose on the deal in the long run.

Doing business with family rarely results in happy parties on both sides.

nelson96

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Re: Need some quick advice...
« Reply #10 on: March 01, 2014, 08:04:13 PM »
Keep in mind, if you take out a "loan" on your 401K, the money you have to earn to "pay yourself back" is POST TAX.  Most folks overlook that fact.  Keep in mind it is taxed again when you retire.  So you REALLY lose on the deal in the long run.

Post tax. . . .  As is in any loan, but with this loan you pay yourself the interest, which is better than paying a bank.  And you get to keep your 401K in place.

FreeLancer is right, you can't liquidate a 401K until you quite the job providing it, so that leaves a loan as the only option, unless you are willing to let this place go and save for a future opportunity.  Any option IMO is better than liquidating your 401K and forfeiting a good portion of it.

.


Offline Tyler Durden

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Re: Need some quick advice...
« Reply #11 on: March 02, 2014, 03:57:48 AM »
... it might be better to take the MIL penalty.

~TG

That is good!

The 401k is from my previous employer so it's kind of just sitting there waiting to be rolled over.  I was figuring since the balance was so small it might be worth it to not have yet another monthly payment (I'm currently trying to dig us out from under a mountain of debt).  I never thought of figuring up a loan that pays MIL back with interest... Definitely something to think about.

Offline Tyler Durden

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Re: Need some quick advice...
« Reply #12 on: March 02, 2014, 04:01:40 AM »
On the 401k loan...  So you have to pay back with interest?  I would have to roll it over first ( to my new employer's plan).  Now that my credit is shot, would that be something I could even do?  I suppose it would be ok because I'm borrowing against my own money.  What are the terms normally for something like that?  I would want to keep the monthly payments low.

nelson96

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Re: Need some quick advice...
« Reply #13 on: March 02, 2014, 09:26:42 AM »
On the 401k loan...  So you have to pay back with interest?  I would have to roll it over first ( to my new employer's plan).  Now that my credit is shot, would that be something I could even do?  I suppose it would be ok because I'm borrowing against my own money.  What are the terms normally for something like that?  I would want to keep the monthly payments low.

Your credit has nothing to do with it, because it's your own money you are borrowing from.  I was able to select the amount of time to pay it off (determines the amount of payment).  The interest rate was something like 4% on mine.

Offline Tyler Durden

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Re: Need some quick advice...
« Reply #14 on: March 03, 2014, 12:56:59 PM »
Thanks to everyone for the advice.  I looked into it and decided to take a loan out against my 401k.  Never would have thought to do that without the input.  Of course, now the bank changed their mind and wants 20k up front, which isn't possible at this time, but if they will settle for less up front that will be the route I'll take.

Thanks again!

Offline CandyGram4Mongo

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Re: Need some quick advice...
« Reply #15 on: March 03, 2014, 06:17:30 PM »
I'd recommend you roll your 401k to an IRA anyway.  Most IRA's can be self-directed (in other words, you can pick which stocks or funds you want your money in, instead of being limited to what your former employer's plan permitted. 
The rollover "should" be free or cost very little, and there aren't any IRS penalties if it's an immediate rollover.  You'll want to shop around to ensure you've got a plan that charges zero/little for the rollover and minimal fees going forward.  Any solid broker will have an "easy button" to help you get this done.  I use Fidelity but I could have used my Credit Union, eTrade, or a lot of other options.  Converting my 401k to an IRA w/Fidelity was very simple and I like their tools to help me manage the account.  I also like the fact that maintaining cash in the Fidelity IRA is easy.
Hopefully there's another thread on this forum that will help you figure out which stocks/funds to put your money in to ensure it grows (or at least doesn't vanish).
Good Luck!
AL

Offline Tyler Durden

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Re: Need some quick advice...
« Reply #16 on: March 14, 2014, 10:59:01 AM »
Well, they are sticking to their 20k up front and won't budge but they dropped the 10 year note part by 5k down to 20k.  I'm taking the advice on this thread and am going to take out a loan out against my 401k, and the rest I'm going to borrow from my MIL.  I'm planning on asking her what the interest rate is on her savings account (that's where her $ is) and drawing up an amortization table based on a 5 year loan for a few tenths of a percent over what she is currently getting.  Then everybody wins.

Thanks again for the help!  You guys and ladies are the best!!!

Offline BillyS

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Re: Need some quick advice...
« Reply #17 on: March 14, 2014, 01:47:54 PM »
I would second Nelson's advice about taking a loan on your 401k.  You and your retirement account are really the only involved parties.  No one else needs to know about your finances, and you aren't liquidating the account permanently.  No penalties and no tax.  Just a thought.

This. There is an option 3 that doesn't kill you with penalties and keeps you out of debt with a relative which is the worst kind of debt to have.

Offline inconel710

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Re: Need some quick advice...
« Reply #18 on: March 14, 2014, 02:21:27 PM »
The only problem with the 401K loan is the potential for penalties if you lose your job for some reason.  The loan has to be repaid in 60 days to avoid paying taxes and penalties for an early withdrawal.  Coughing up $10k or paying the IRS an extra grand or two after you've been fired or had a disabling injury might be a little tough.

Offline Duc1

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Re: Need some quick advice...
« Reply #19 on: March 17, 2014, 03:50:10 PM »
I would look for another source, $1,300 (10%) penalty to the IRS, plus 100% taxable income.  So, if you're in the 20% tax bracket you would pay $1,300 plus $2,600, plus state tax $750 or whatever your state is.  This would net $8,350..

nelson96

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Re: Need some quick advice...
« Reply #20 on: March 17, 2014, 05:03:38 PM »
I would look for another source, $1,300 (10%) penalty to the IRS, plus 100% taxable income.  So, if you're in the 20% tax bracket you would pay $1,300 plus $2,600, plus state tax $750 or whatever your state is.  This would net $8,350..

That puts it in to perspective. . . .  Today you have $13K then next you have $8,350 with nothing to show for the loss. 

Offline bigbear

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Re: Need some quick advice...
« Reply #21 on: March 18, 2014, 12:57:31 PM »
Most 401k plans don't allow for a loan to a terminated employee anyway.  But if I were still employed by the company, I would rather take a loan from my 401k than from a bank.  And YMMV with family.

Yes, it's after-tax money that repays the loan.  But you're paying yourself back with interest.  If you got a loan from a bank, you'd be repaying that with after-tax money too, plus interest would be lost.  If the bank writes the loan off, it's considered earned income too.  Also, the interest rate for a 401k loan is typically very close to prime (like prime +.5%).  It varies by company.

You should be able to contact the 401k provider to model various terms of the loan.  The longest you can take a standard loan is for 5 years (though plans can have a shorter term period).  The longest residential loan is for 15 years (again, it can be less).  I modeled a $13k loan for 5 years at 4.25% and the bi-weekly payments were about $110.

If you leave your company, most plans will require you pay the loan off in full.  Though some allow for manual payments to continue. 

If you're required to pay it off, then you typically are given a couple of months before the loan is written off and taxable.  The remaining prinicple is considered earned income and a 10% excise penalty is applied.

The risk is remaining with the company or being able to get your hands on money to payoff the loan if you're not with the company.

Offline Tyler Durden

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Re: Need some quick advice...
« Reply #22 on: March 20, 2014, 02:30:49 PM »
And as far as I'm concerned, any of these options beats getting sued by the bank for the entire sum I owe.  I don't have much in my 401k anyway.  The lady I talked to at Fidelity recommended I contribute 8% to my 401k rather than the 1% I currently do since my company matches 50 cents on the dollar up to that point.  I told her I would if my situation wasn't abysmal, I would. 

I'm not talking about casually borrowing from my 401k as routine.  This is another weapon in my "nuclear arsenal" to try and get my financial ducks in a row.  The events that are unfolding are as Jack described, chemotherapy for my debt cancer.
« Last Edit: March 20, 2014, 02:41:39 PM by Shirley Temple »

Offline Morgan96

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Re: Need some quick advice...
« Reply #23 on: March 23, 2014, 09:17:17 AM »
I can say we've done both:  borrow from MIL at 3% to purchase a new vehicle, and take a loan from the 401(k) to partially finance property.  Both were options of last resort, but worked out OK.  Both loans repaid ahead of schedule, one less than 6 months later.