401k Loan

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raamakoti
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401k Loan

Post by raamakoti »

This is ideal mind curiosity -
My current 401k is at about 200k stable job earning $124k a year. does it make sense to borrow 50k from 401k, because market is sitting at all time high and a decent correction is due anyways.
did anyone else have a crazy thoughts like I am having. Is there a tool to find the true cost of borrowing money from 401k.
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David Jay
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Re: 401k Loan

Post by David Jay »

raamakoti wrote: Wed Jun 16, 2021 9:20 pmdid anyone else have a crazy thoughts like I am having.
Nope.
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grabiner
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Re: 401k Loan

Post by grabiner »

Whether you should take a loan is independent of how much stock you should hold.

If you hold too much stock for your risk tolerance, you should sell some stock in your 401(k) or IRA, and move the money to a lower-risk investment such as a bond fund. If you do this, that should be a permanent move. To get the benefit of the returns of an 80%-stock portfolio, you need to keep it at 80% stock regardless of what happens to the market; if you won't do this but can stick with a 60%-stock portfolio, hold 60% stock and keep that allocation.

The reason to take out a loan from the 401(k) is that you need the money outside the 401(k). If you are going to keep the money invested, it should stay inside the 401(k) because of the tax advantages. But if you need money for some purpose such as a home down payment, you could take a 401(k) loan if that happens to be the best way to get the money. And you can do this without changing the amount of stock, by taking the loan from a bond fund (or, if the 401(k) forces you to take any loan proportionally, rebalancing the 401(k) after you take out the loan so that you hold just as much stock as before.)
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Brianmcg321
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Re: 401k Loan

Post by Brianmcg321 »

NEVER borrow money from your 401k. EVER.

Curious. Why do you think a "decent" correction is due?
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eye.surgeon
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Re: 401k Loan

Post by eye.surgeon »

Nope.
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London
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Re: 401k Loan

Post by London »

Brianmcg321 wrote: Thu Jun 17, 2021 12:41 am NEVER borrow money from your 401k. EVER.

Curious. Why do you think a "decent" correction is due?
I disagree. There are cases where it makes sense. It’s a financial tool at your disposal.

I’m not sure I would do it in this use case, but that’s up to OP.
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RickBoglehead
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Re: 401k Loan

Post by RickBoglehead »

OP has been on the forum for 4 years and hasn't picked up on the failings of market timing and not borrowing from a 401k? Or that a 401k may not let you make contributions while you have a loan outstanding?

https://www.investopedia.com/articles/r ... ns401k.asp
Last edited by RickBoglehead on Thu Jun 17, 2021 6:40 am, edited 1 time in total.
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markjk
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Re: 401k Loan

Post by markjk »

I wouldn't do it. The more you play around with your retirement like this, the bigger the chance you'll lose out in the long run. Right off the bat, if you remove 50k from your 401k then you'll remove the ability for that money to compound for as long as it takes for you to pay it back. A 401k loan should be a last ditch emergency option, nothing more.
260chrisb
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Re: 401k Loan

Post by 260chrisb »

raamakoti wrote: Wed Jun 16, 2021 9:20 pm This is ideal mind curiosity -
My current 401k is at about 200k stable job earning $124k a year. does it make sense to borrow 50k from 401k, because market is sitting at all time high and a decent correction is due anyways.
did anyone else have a crazy thoughts like I am having. Is there a tool to find the true cost of borrowing money from 401k.
No it makes no sense! Short of maybe avoiding a bankruptcy or foreclosure one should NEVER borrow from a retirement account. You can of course reduce your contributions in the short term to generate funds. It's none of my business but what would you use the money for? If it were me I wouldn't spend any time trying to determine the true cost of such loans. Are you trying to protect part of your money from the decent correction forthcoming? That's fine but not via a loan.
Grt2bOutdoors
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Re: 401k Loan

Post by Grt2bOutdoors »

Do you want to retire someday or do you believe playing the market timing lottery is a more advantageous method of retirement? Go read the countless threads on why market timing is a fools errand. Just 1 thing to think about - instead of 200k working for you, you will now have 150k working you and you will be paying interest plus principal back to the plan. How do you consider that a win, especially since there is no current higher yielding investment anywhere that exceeds the cost of borrowing the money?
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Miguelito
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Re: 401k Loan

Post by Miguelito »

I would not borrow for the purposes of timing the market.

We borrowed money from a 401k. The first time was to help pay for our house remodel and we were lucky the market value was about the same when it was repaid a year later. It was not a smart move and it was a long time ago. That said, we had good incomes for being young.

The second time it was to complete down payment on our new house while we still had the old one. That was repaid in two months with the equity of the first home when it sold. It was a very short bridge loan.
Last edited by Miguelito on Thu Jun 17, 2021 2:51 pm, edited 1 time in total.
n0v0w3ls
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Re: 401k Loan

Post by n0v0w3ls »

Don't do it for the reason you mentioned. As others mentioned, market timing rarely works in your favor. If you strongly think that the market is due for a correction, why not just change your asset allocation to cash within the plan?

I see people often emphasize the risks of losing a job and having the loan due, or that some plans restrict contributions when loans are out and the possible damage to long term savings. One huge con (the biggest to me) is that I don't see mentioned nearly as often is that 401k loan payments are made after tax. Sure the interest is paid to your own account, but you also need to have $75k in income to repay a $50k loan. Then you retire and pay tax on it again when you withdraw it.
Stormfloatter
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Re: 401k Loan

Post by Stormfloatter »

You may have the best reasons an intentions: do not do it.

You do not need to learn from your mistakes. Just learn from mine…
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goingup
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Re: 401k Loan

Post by goingup »

No. Think of that as money locked in the vault, to be opened upon retirement.

What would be your plan if you took out $50K? Is there something better to with it than let it grow tax-free in the vault for decades? :?:
LongRoad
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Re: 401k Loan

Post by LongRoad »

n0v0w3ls wrote: Thu Jun 17, 2021 7:59 am I see people often emphasize the risks of losing a job and having the loan due, or that some plans restrict contributions when loans are out and the possible damage to long term savings. One huge con (the biggest to me) is that I don't see mentioned nearly as often is that 401k loan payments are made after tax. Sure the interest is paid to your own account, but you also need to have $75k in income to repay a $50k loan. Then you retire and pay tax on it again when you withdraw it.
Not to derail the thread, but this issue has been discussed before. ANY loan (conventional or 401k) will be repaid with after-tax dollars, so there is no special tax disadvantage to borrowing from your 401k versus taking the same loan from elsewhere. This still does not make it a good idea.
VoiceOfReason
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Re: 401k Loan

Post by VoiceOfReason »

LongRoad wrote: Thu Jun 17, 2021 8:05 am
n0v0w3ls wrote: Thu Jun 17, 2021 7:59 am I see people often emphasize the risks of losing a job and having the loan due, or that some plans restrict contributions when loans are out and the possible damage to long term savings. One huge con (the biggest to me) is that I don't see mentioned nearly as often is that 401k loan payments are made after tax. Sure the interest is paid to your own account, but you also need to have $75k in income to repay a $50k loan. Then you retire and pay tax on it again when you withdraw it.
Not to derail the thread, but this issue has been discussed before. ANY loan (conventional or 401k) will be repaid with after-tax dollars, so there is no special tax disadvantage to borrowing from your 401k versus taking the same loan from elsewhere. This still does not make it a good idea.
Agreed. Additionally in this scenario where there is no purpose for the $, it's just an attempt to time the market. The $$ could be sitting in a HYS or brokerage account just waiting to repay the 401k loan.

One of the biggest downsides that gets overlooked is that many 401k plans will restrict your future contributions while you have a 401k loan. Either for a time period, by % or entirely until the loan is repaid. Each plan is different and while some do not restrict many of them will.
thewizenut
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Re: 401k Loan

Post by thewizenut »

There are 3 things to consider when you take out a 401(k) loan:

1. Taxation
2. Taxation
3. Taxation

ok maybe 4:

4. WE ARENT MARKET TIMERS

There's a lot of misinformation on this topic (not here, just in general). Would be best to speak with a tax advisor.

What I DO know is that:

1. You pay taxes on AT LEAST the interest on the loan. Possibly the principal too. I see conflicting information when I Google it.

2. If you leave your job, there is the potential for a 10% penalty on the distribution and paying taxes on the whole distribution (the loan turns into a pre-retirement age distribution). This is if you can't pay the loan back in full right away when you leave your job. And if you're putting it into the market, there is a good chance you won't have the market value to do this (maybe you have extra cash lying around? In which case you should just put THAT money in the market instead).

3. You then pay taxes AGAIN on the interest you paid back into your 401(k) from the loan when you take distributions in retirement.

Links from credible sources:

https://www.fidelity.com/viewpoints/fin ... -from-401k
https://www.irs.gov/retirement-plans/co ... 01k-plan-2

Less credible but seems legitimate:

Go to the "Debunking Myths With Facts" section: https://www.investopedia.com/articles/r ... k-loan.asp

This part is interesting because the tax inefficiency may be much less depending on other financing options.

4. Unless your interest rate is extremely low (sub 2%) and you have sources of liquidity to pay the loan back at a moment's notice, you risk a large penalty for a defaulted loan (see item 2. above) because the market fluctuates. if you have a line of credit or pool of liquidity you KNOW you can tap into to avoid that consequence, this seems like more trouble than it's worth.

-----

I would love someone to skewer my argument. I have looked at this option myself many times and would love for someone to find a way to make it work. It's like a good puzzle. Very satisfying.

-----

Glad you asked the question though, it's good to explore all the different ways to slice the onion.

Best of luck.
Trader Joe
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Re: 401k Loan

Post by Trader Joe »

raamakoti wrote: Wed Jun 16, 2021 9:20 pm This is ideal mind curiosity -
My current 401k is at about 200k stable job earning $124k a year. does it make sense to borrow 50k from 401k, because market is sitting at all time high and a decent correction is due anyways.
did anyone else have a crazy thoughts like I am having. Is there a tool to find the true cost of borrowing money from 401k.
No, I do not recommend this at all.
SubPar
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Re: 401k Loan

Post by SubPar »

LongRoad wrote: Thu Jun 17, 2021 8:05 am
n0v0w3ls wrote: Thu Jun 17, 2021 7:59 am I see people often emphasize the risks of losing a job and having the loan due, or that some plans restrict contributions when loans are out and the possible damage to long term savings. One huge con (the biggest to me) is that I don't see mentioned nearly as often is that 401k loan payments are made after tax. Sure the interest is paid to your own account, but you also need to have $75k in income to repay a $50k loan. Then you retire and pay tax on it again when you withdraw it.
Not to derail the thread, but this issue has been discussed before. ANY loan (conventional or 401k) will be repaid with after-tax dollars, so there is no special tax disadvantage to borrowing from your 401k versus taking the same loan from elsewhere. This still does not make it a good idea.
Isn't the whole idea here that you're replacing $50K of pre-tax contributions with $50K of after-tax contributions, thus negating the tax benefit of the original contribution? And then, of course, you'll be paying tax on that $50K again upon withdrawal, opening yourself up to double taxation on your loan principal amount.

Not trying to argue, just want to correct my understanding if I've had it wrong this whole time.
London
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Re: 401k Loan

Post by London »

thewizenut wrote: Thu Jun 17, 2021 8:18 am There are 3 things to consider when you take out a 401(k) loan:

1. Taxation
2. Taxation
3. Taxation

ok maybe 4:

4. WE ARENT MARKET TIMERS

There's a lot of misinformation on this topic (not here, just in general). Would be best to speak with a tax advisor.

What I DO know is that:

1. You pay taxes on AT LEAST the interest on the loan. Possibly the principal too. I see conflicting information when I Google it.

2. If you leave your job, there is the potential for a 10% penalty on the distribution and paying taxes on the whole distribution (the loan turns into a pre-retirement age distribution). This is if you can't pay the loan back in full right away when you leave your job. And if you're putting it into the market, there is a good chance you won't have the market value to do this (maybe you have extra cash lying around? In which case you should just put THAT money in the market instead).

3. You then pay taxes AGAIN on the interest you paid back into your 401(k) from the loan when you take distributions in retirement.

Links from credible sources:

https://www.fidelity.com/viewpoints/fin ... -from-401k
https://www.irs.gov/retirement-plans/co ... 01k-plan-2

Less credible but seems legitimate:

Go to the "Debunking Myths With Facts" section: https://www.investopedia.com/articles/r ... k-loan.asp

This part is interesting because the tax inefficiency may be much less depending on other financing options.

4. Unless your interest rate is extremely low (sub 2%) and you have sources of liquidity to pay the loan back at a moment's notice, you risk a large penalty for a defaulted loan (see item 2. above) because the market fluctuates. if you have a line of credit or pool of liquidity you KNOW you can tap into to avoid that consequence, this seems like more trouble than it's worth.

-----

I would love someone to skewer my argument. I have looked at this option myself many times and would love for someone to find a way to make it work. It's like a good puzzle. Very satisfying.

-----

Glad you asked the question though, it's good to explore all the different ways to slice the onion.

Best of luck.
I’m not going to try to debunk your points, but I want to add that one reason why 401k loans have an advantage is that it’s quick cash that doesn’t show up on your credit report. So in a case where you own one home and you are buying another home first, you can use a 401k loan as temporary liquidity that doesn’t impact you debt to income ratio.

All points about downsides may be reasonable but let’s not pretend there’s no utility.
LongRoad
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Re: 401k Loan

Post by LongRoad »

SubPar wrote: Thu Jun 17, 2021 8:22 am
LongRoad wrote: Thu Jun 17, 2021 8:05 am
n0v0w3ls wrote: Thu Jun 17, 2021 7:59 am I see people often emphasize the risks of losing a job and having the loan due, or that some plans restrict contributions when loans are out and the possible damage to long term savings. One huge con (the biggest to me) is that I don't see mentioned nearly as often is that 401k loan payments are made after tax. Sure the interest is paid to your own account, but you also need to have $75k in income to repay a $50k loan. Then you retire and pay tax on it again when you withdraw it.
Not to derail the thread, but this issue has been discussed before. ANY loan (conventional or 401k) will be repaid with after-tax dollars, so there is no special tax disadvantage to borrowing from your 401k versus taking the same loan from elsewhere. This still does not make it a good idea.
Isn't the whole idea here that you're replacing $50K of pre-tax contributions with $50K of after-tax contributions, thus negating the tax benefit of the original contribution? And then, of course, you'll be paying tax on that $50K again upon withdrawal, opening yourself up to double taxation on your loan principal amount.

Not trying to argue, just want to correct my understanding if I've had it wrong this whole time.
No, because you're receiving the loan proceeds after-tax (tax-free) and replacing them in the 401k with the same after tax dollars when you repay the loan.

Your understanding about being double-taxed would be correct if you had to pay tax on the loan proceeds when borrowing, but you don't.
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JonnyDVM
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Re: 401k Loan

Post by JonnyDVM »

London wrote: Thu Jun 17, 2021 6:12 am
Brianmcg321 wrote: Thu Jun 17, 2021 12:41 am NEVER borrow money from your 401k. EVER.

Curious. Why do you think a "decent" correction is due?
I disagree. There are cases where it makes sense. It’s a financial tool at your disposal.

I’m not sure I would do it in this use case, but that’s up to OP.
I took a 401k loan to help cover the cost of a down payment for a new house until we put the old one up for sale. It was quickly repaid. So there are occasional good uses for 401k loans.

Not this one though. It sounds like OP wants to take a loan on a whim and do nothing specific with it. I’m not understanding what OP wants to do? You don’t have to take a 401k loan to try to time the market with a 401k, you just sell assets within the 401k. Unless you’re buying real estate maybe?
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thewizenut
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Re: 401k Loan

Post by thewizenut »

London wrote: Thu Jun 17, 2021 8:25 am
thewizenut wrote: Thu Jun 17, 2021 8:18 am There are 3 things to consider when you take out a 401(k) loan:

1. Taxation
2. Taxation
3. Taxation

ok maybe 4:

4. WE ARENT MARKET TIMERS

There's a lot of misinformation on this topic (not here, just in general). Would be best to speak with a tax advisor.

What I DO know is that:

1. You pay taxes on AT LEAST the interest on the loan. Possibly the principal too. I see conflicting information when I Google it.

2. If you leave your job, there is the potential for a 10% penalty on the distribution and paying taxes on the whole distribution (the loan turns into a pre-retirement age distribution). This is if you can't pay the loan back in full right away when you leave your job. And if you're putting it into the market, there is a good chance you won't have the market value to do this (maybe you have extra cash lying around? In which case you should just put THAT money in the market instead).

3. You then pay taxes AGAIN on the interest you paid back into your 401(k) from the loan when you take distributions in retirement.

Links from credible sources:

https://www.fidelity.com/viewpoints/fin ... -from-401k
https://www.irs.gov/retirement-plans/co ... 01k-plan-2

Less credible but seems legitimate:

Go to the "Debunking Myths With Facts" section: https://www.investopedia.com/articles/r ... k-loan.asp

This part is interesting because the tax inefficiency may be much less depending on other financing options.

4. Unless your interest rate is extremely low (sub 2%) and you have sources of liquidity to pay the loan back at a moment's notice, you risk a large penalty for a defaulted loan (see item 2. above) because the market fluctuates. if you have a line of credit or pool of liquidity you KNOW you can tap into to avoid that consequence, this seems like more trouble than it's worth.

-----

I would love someone to skewer my argument. I have looked at this option myself many times and would love for someone to find a way to make it work. It's like a good puzzle. Very satisfying.

-----

Glad you asked the question though, it's good to explore all the different ways to slice the onion.

Best of luck.
I’m not going to try to debunk your points, but I want to add that one reason why 401k loans have an advantage is that it’s quick cash that doesn’t show up on your credit report. So in a case where you own one home and you are buying another home first, you can use a 401k loan as temporary liquidity that doesn’t impact you debt to income ratio.

All points about downsides may be reasonable but let’s not pretend there’s no utility.
Excellent! Thank you for this. That's a good way to use it. For Real Estate deals in particular, if you can pony up the cash quick, that can help close the deal, and sometimes at a better price. ty ty ty
wootwoot
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Re: 401k Loan

Post by wootwoot »

raamakoti wrote: Wed Jun 16, 2021 9:20 pm This is ideal mind curiosity -
My current 401k is at about 200k stable job earning $124k a year. does it make sense to borrow 50k from 401k, because market is sitting at all time high and a decent correction is due anyways.
did anyone else have a crazy thoughts like I am having. Is there a tool to find the true cost of borrowing money from 401k.
Why not just move into less risky assets in your 401k?
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Ketawa
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Re: 401k Loan

Post by Ketawa »

The OP's reason would be a bad reason to take a 401k loan. There are plenty of good reasons, like using the proceeds for a down payment.

If an investor is not 100% equities, a 401k loan can be an opportunity to access fixed income investments in tax-advantaged to pay down debt, which can be an arbitrage of interest rates.

The concerns about taxation are overblown. A 401k loan can be paid back with after-tax dollars, but one can't ignore the benefit of being able to use never-taxed dollars for another purpose (if withdrawing from a 100% Traditional 401k). Just imagine you had the 401k loan proceeds sitting in a savings account for a year, then paid paid the 401k loan. Were those dollars after-tax? What happens if you pay it back from income and use the 401k loan for something else? You still have that benefit.

A loan from a Roth 401k would not have any tax consequences.

The loan interest is only double taxed to the extent that contributions to a non-deductible Traditional IRA are double-taxed. The portion of payments that is loan interest can be considered similar to non-deductible Traditional IRA contributions. There is an entire wiki article comparing non-deductible Traditional IRAs to taxable accounts, and non-deductible Traditional IRAs are only disadvantaged by 5% at worst cumulative over 40 years, and sometimes better than taxable accounts. Non-deductible traditional IRA
knowledge
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Re: 401k Loan

Post by knowledge »

There should be a better way to make this trade without resorting to borrowing from your 401k.

That said, I do think a 401k loan is a useful tool for the right purposes. I still have a 401k loan balance which I took out to help fund a house downpayment from 2 years ago instead of incurring capital gains in my taxable account. I have the cash to pay this off readily available, but in the meantime I've been paying myself 6.5% interest. Ideally, I would have paid the entire balance on April 2020, but I didn't.

So to the OP: consider my case. You could be wrong and you'd end up taking a chunk out of the market while the market is good.
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raamakoti
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Re: 401k Loan

Post by raamakoti »

Thank you all for sharing your wisdom, I won’t do it some YouTube videos and light reading on the topic got my thoughts going in the direction. Before I become too vested in the idea I checked here to evaluate the idea.
IMO
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Re: 401k Loan

Post by IMO »

SubPar wrote: Thu Jun 17, 2021 8:22 am
LongRoad wrote: Thu Jun 17, 2021 8:05 am
n0v0w3ls wrote: Thu Jun 17, 2021 7:59 am I see people often emphasize the risks of losing a job and having the loan due, or that some plans restrict contributions when loans are out and the possible damage to long term savings. One huge con (the biggest to me) is that I don't see mentioned nearly as often is that 401k loan payments are made after tax. Sure the interest is paid to your own account, but you also need to have $75k in income to repay a $50k loan. Then you retire and pay tax on it again when you withdraw it.
Not to derail the thread, but this issue has been discussed before. ANY loan (conventional or 401k) will be repaid with after-tax dollars, so there is no special tax disadvantage to borrowing from your 401k versus taking the same loan from elsewhere. This still does not make it a good idea.
Isn't the whole idea here that you're replacing $50K of pre-tax contributions with $50K of after-tax contributions, thus negating the tax benefit of the original contribution? And then, of course, you'll be paying tax on that $50K again upon withdrawal, opening yourself up to double taxation on your loan principal amount.

Not trying to argue, just want to correct my understanding if I've had it wrong this whole time.
If you take out a $50K loan that was put in "pre-tax", you get the whole $50K dollars in the loan. In other words, it is NOT now taxed at your current income rates and you are not penalized 10% for an early withdrawal fee. There may be a fee to initiate the loan itself (say $100 fee). You now have to pay back that full $50K to your 401K. The catch is you have to pay an interest rate on the loan, which varies upon one's particular 401K plan. The best I know of is the Fed's TSP plan. The interest on the loan is "paid to yourself".

IF you lose your job you have a set time to repay back the full amount outstanding on your loan. If you fail to do that, then you WILL be taxed on the balance of the loan at your current income tax rate, and be hit with the 10% early withdrawal fee (there are exceptions to this but we'll ignore those).

Can it work out in one's advantage? There are situations. For example, you pull out a $50K loan (and say it has a 2% interest rate) where your funds were invested in something similar to a S&P 500 plan/total market fund. The stock market then goes into a negative return period while you are paying back the loan to your 401K. You've just successfully market timed.

It goes the opposite way. You take out $50K because the market is in a flat period and before your get your funds back in, the market had gone up significantly. You've just unsuccessfully market timed.

One would also need to consider what was done with the $50K you pulled out. If one put into some other investment, the performance of the other investment would determine if your decision was good or bad in hindsight.
APX32
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Re: 401k Loan

Post by APX32 »

401k loans can be a good financial tool at one’s disposal, if used for the right reasons such as a bridge loan for a real estate transaction or paying cash to buy a car. I’ve done both a total of 3 times over the years, and each time the loan was paid back in < 12 months. Since you only pay taxes on the interest (please look up the double taxation myth as already explained by several posters), the amount is negligible if the loan is repaid quickly.

I’ve finally gotten to a point now in my investing life where I have more than sufficient cash for pretty much anything without ever ending a 401k loan. But I’m glad the option was there during the times when I needed it with a plan to pay it back quickly.
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gpburdell
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Re: 401k Loan

Post by gpburdell »

London wrote: Thu Jun 17, 2021 6:12 am I disagree. There are cases where it makes sense. It’s a financial tool at your disposal.

I’m not sure I would do it in this use case, but that’s up to OP.
I agree with your disagreement. A couple years ago I took out a 50k loan so I could buy a new house. This let me buy the new house before selling the old one first and be able to move on our own schedule.

I made sure the 401k plan didn't have anything like immediate repayment if I left the company, terminated etc. Once I sold the old house, I paid off the loan. I wouldn't do what the OP is implying to take the loan and do something risky like buy bitcoin.
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sunny_socal
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Joined: Tue Mar 24, 2015 4:22 pm

Re: 401k Loan

Post by sunny_socal »

A 401k loan is great for short-term borrowing, eg. for a house down payment
- It is approved instantly, the money is in your account within a couple days
- Mortgage lenders don't "see" the debt! It's your existing money so it's not counted against you
- You can pay it back at your convenience. I wouldn't keep it out longer than 6M.
- Probably the best "bridge loan" type money available. Would you rather go to a "hard money" lender who charges 20%?

Would I allow that loan stay out permanently or take any other 401k withdrawal? No.
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