Author Topic: Pay back 401K loan or let it ride?  (Read 1045 times)

August26th

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Pay back 401K loan or let it ride?
« on: October 17, 2019, 02:14:33 PM »
I canít wrap my head around the math, so Iím coming to the MMM Forums for the win!

I took out a 38K 401k loan about a year ago. Put it into an investment opportunity that has proven to be very wise. To repay the loan, I am making twice-monthly payments at 6% for $372 each. Coming out of my work paycheck, obviously.

I am in a cash position now to pay in full the almost 31K that I still owe. But the $372 per paycheck is a payment I donít even feel.

I have no plans to leave my employer and it is very stable.

Question is.......   do I pay it off now in full, or just let it ride? The funds are currently in a 2-ish% online savings, BUT I could put it into my Vanguard brokerage and invest in something according to my asset allocation.

Thoughts on what I should do? Thanks in advance.

Telecaster

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Re: Pay back 401K loan or let it ride?
« Reply #1 on: October 17, 2019, 02:21:57 PM »
Pay it off.

Boofinator

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Re: Pay back 401K loan or let it ride?
« Reply #2 on: October 17, 2019, 02:35:28 PM »
Pay it off.

Ditto. And then max your 401k contributions if you aren't already. Then, put additional money into your Vanguard brokerage.

August26th

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Re: Pay back 401K loan or let it ride?
« Reply #3 on: October 17, 2019, 02:45:36 PM »
Iíve already maxed out 401K and Roth IRA.

Any rationale behind paying it off?

Guizmo

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Re: Pay back 401K loan or let it ride?
« Reply #4 on: October 17, 2019, 02:46:51 PM »
Does the 6% interest go to you? If so, I would say it probably doesn't matter that much. If you are paying an institution 6% so you can make 2% in an online account then pay it off.

August26th

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Re: Pay back 401K loan or let it ride?
« Reply #5 on: October 17, 2019, 02:47:51 PM »
The 6% is paid back to me/my 401k plan.

terran

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Re: Pay back 401K loan or let it ride?
« Reply #6 on: October 17, 2019, 02:57:25 PM »
Assuming you'd invest this money either way (pay off the loan and invest in the 401(k) or don't pay off the loan and invest in taxable) I suppose it comes down to whether you think your investments will return more than 6% (on average stock investments have returned more in the past) and whether you'd rather have more in taxable or in a tax deferred 401(k). You'll pay tax on dividends as you go in taxable creating tax drag, but qualified dividends and long term capital gains will be taxed at long term capital gains rates (which could be 0% if you hold until retirement) and you may be able to take advantage of tax loss harvesting along the way. You'll pay at your marginal income tax rate in retirement which may be higher or lower than your current capital gains rate depending on your income now and then.

If you decide it's a tossup I'd come down in favor of paying off the loan since there are some risks (however small) of losing your job and having to pay back the loan quickly. Also remember to account for and loan servicing fees your 401(k) provider might charge while you still have a loan balance.

Telecaster

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Re: Pay back 401K loan or let it ride?
« Reply #7 on: October 17, 2019, 05:40:41 PM »
Assuming you'd invest this money either way (pay off the loan and invest in the 401(k) or don't pay off the loan and invest in taxable) I suppose it comes down to whether you think your investments will return more than 6% (on average stock investments have returned more in the past) and whether you'd rather have more in taxable or in a tax deferred 401(k).

Think about that one for a second.  If you pay 6% interest on a loan you made to yourself, how much are you actually earning?

Answer:  Zero!  You are making zero percent interest. 

And remember, the money goes into the 401(k) pre-tax, but the loan gets paid back post tax.  So the actual cost is whatever your effective tax rate is.  Probably not zero.  So the longer the OP keeps the loan, the more post-tax dollars he needs to cough up in order to pay for the pre-tax dollars he borrowed.  I would kill that thing ASAP. 

   

terran

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Re: Pay back 401K loan or let it ride?
« Reply #8 on: October 17, 2019, 09:11:38 PM »
Assuming you'd invest this money either way (pay off the loan and invest in the 401(k) or don't pay off the loan and invest in taxable) I suppose it comes down to whether you think your investments will return more than 6% (on average stock investments have returned more in the past) and whether you'd rather have more in taxable or in a tax deferred 401(k).

Think about that one for a second.  If you pay 6% interest on a loan you made to yourself, how much are you actually earning?

Answer:  Zero!  You are making zero percent interest. 

And remember, the money goes into the 401(k) pre-tax, but the loan gets paid back post tax.  So the actual cost is whatever your effective tax rate is.  Probably not zero.  So the longer the OP keeps the loan, the more post-tax dollars he needs to cough up in order to pay for the pre-tax dollars he borrowed.  I would kill that thing ASAP. 

I never said you were actually earning 6%, I said if you believe the money will earn more than 6% invested then you should invest the money in the place you want to have more money, and vice versa.

You can either pay off the loan and invest in the 401(k) or not pay of the loan and invest outside the 401(k). If you want more money inside the 401(k) and less outside the 401(k) then you should pay back the loan if you believe the market will return more than 6% because you will have greater than 6% more inside the 401(k) from investing. If you want less money in the 401(k) and more outside the 401(k) then you should not pay back the loan if you believe the market will return more than 6% because you will have 6% more inside the 401(k) from paying back the loan later and the money outside will grow by more than 6% by being invested. If you believe the market will return less than 6% then you should do the opposite depending on you desired outcome (more/less insider/outside the 401(k)).

All that to say, all else being equal, you won't end up with more money with either option except to the extent that the tax treatment of the money will be different, so it all comes down to where you want more money and whether you think the market will return more or less than the 6% that will end up inside the 401(k) if you pay it back as slowly as you can.

Edit: to your point about pre/post tax dollars, see: https://thefinancebuff.com/401k-loan-double-taxation-myth.html
« Last Edit: October 17, 2019, 09:28:08 PM by terran »