Author Topic: 401k loan repayment question.  (Read 7571 times)

UnleashHell

  • Walrus Stache
  • *******
  • Posts: 6543
  • Age: 52
  • Location: Florida
  • Chapter IV - A New ... er.. something
401k loan repayment question.
« on: January 05, 2015, 08:39:00 AM »
I have a 401k loan that I’d like to repay – its currently being paid at 400 a month at a rate of 3.5% and will take forever to repay!!
The only way to repay it is as a lump sum – I can’t increase the payment amount on the terms of the loan.
If I was to be able to repay it then I could increase the wifes 401k contribution by the amount (and a bit more) than I am repaying the 401k at – and with the benefits in that account I could decrease our taxes further while increasing the amount we are investing!

I’m currently maxing the 401k contributions in my account but the repayments of the loan would get that money to work in a tax advantaged account and more importantly – if I leave work I don’t have to concern myself with this being called in and counted as taxable income plus a penalty.

I also have an IRA. Now from what I understand I can pull money out of the IRA and as long as I reinvested in another IRA or 401k within 60 days then it doesn’t count as a cash withdraw – so no tax or penalty on that amount.

So – if I pulled out the an amount of money from the IRA and transferred it to the 401k can I then get that counted as the loan repayment?

(I doubt it – seems too easy – but I’d like to be sure)

DoubleDown

  • Handlebar Stache
  • *****
  • Posts: 1989
Re: 401k loan repayment question.
« Reply #1 on: January 05, 2015, 10:20:36 AM »
(I doubt it – seems too easy – but I’d like to be sure)

Yup, your intuition is good -- you can't do this unfortunately. The loan has to be repaid using your own non-tax deferred funds.

If it helps, think of it this way: When you received the loan, say $10k, you got a (temporarily) tax-deferred distribution. If all you did was move $10k from another tax-deferred account (your IRA) to the 401k, you would still have a $10k distribution that has not been accounted for. That is, you would have $20k in tax-deferred deductions, but only $10k in tax-deferred credits.

27y/oTennesseeRetiree

  • 5 O'Clock Shadow
  • *
  • Posts: 49
Re: 401k loan repayment question.
« Reply #2 on: January 05, 2015, 10:31:25 AM »
Can he withdrawl contributions to the Traditional IRA without penalty? He would just have to pay taxes at his ordinary income rate right? (I use a Roth, so I am a bit out of my depth. )

If so, he could withdrawl the funds and pay off the loan without running into the problem above. It's the beginning of the year... so he could offset about $4800 of whatever he draws by increasing the contribution to his wife's 401k assuming they are filing jointly.

I'm not sure what the loan balance is, and I would be sure it didn't incur a penalty from early withdrawl on the IRA, and that it doesn't push him into a higher tax bracket. But if all of those things check out... it could work.

UnleashHell

  • Walrus Stache
  • *******
  • Posts: 6543
  • Age: 52
  • Location: Florida
  • Chapter IV - A New ... er.. something
Re: 401k loan repayment question.
« Reply #3 on: January 05, 2015, 11:42:13 AM »
Not worth doing the IRA drawdown – I’ll get hit with taxes and the penalty – plus I’d have to take down too much to balance with the wifes contributions. Guess I’ll do it the old fashioned way –save up!!!

OR take a loan against the house – a fixed loan means I can have the same outgoings but also increase the wifes contribution for the tax benefit.

Oh well – was just a thought…

b4u2

  • Pencil Stache
  • ****
  • Posts: 627
  • Age: 41
  • Location: Cedar Rapids, IA
Re: 401k loan repayment question.
« Reply #4 on: January 05, 2015, 11:48:00 AM »
Not worth doing the IRA drawdown – I’ll get hit with taxes and the penalty – plus I’d have to take down too much to balance with the wifes contributions. Guess I’ll do it the old fashioned way –save up!!!

OR take a loan against the house – a fixed loan means I can have the same outgoings but also increase the wifes contribution for the tax benefit.

Oh well – was just a thought…

The 401k loan interest is going to yourself. Would you gain enough in tax breaks to cover a loan against the house?

DoubleDown

  • Handlebar Stache
  • *****
  • Posts: 1989
Re: 401k loan repayment question.
« Reply #5 on: January 05, 2015, 12:00:37 PM »
Not sure I understood what you meant about a home loan and what that has to do with increasing your wife's contributions....

At any rate (haha, no pun intended), as annoying as the 401k loan might be to you, you could just continue to make the monthly payments until it's eventually paid off. A rate of 3.5% is awfully low, so assuming your investments include a healthy percentage of stocks you're likely doing considerably better than 3.5% in returns.

Sid Hoffman

  • Pencil Stache
  • ****
  • Posts: 743
  • Location: Southwest USA
Re: 401k loan repayment question.
« Reply #6 on: January 05, 2015, 12:25:20 PM »
This didn't sound like a good plan to me, so I ran some sample numbers:

401k: $100k with $50k loan (Balance of $50k invested)
IRA: $50k

Total tax-advantaged balance: $100k

Scenario 1:Transfer money from IRA to pay off 401k
Result: $100k with $0 loan
IRA: $0
Total tax-advantaged balance: $100k

Scenario 2: Pay off loan over 5 years at 3.5%
Result $104.5k with $0 loan
IRA $50k
Total tax advantaged balance: $154.5k

You cannot do a directed transfer as a loan payoff, but even if you could, clearly this does you no favor at all based on the numbers above.  I would just save up money in a regular savings account to pay off the 401k loan.  If it's a 5-year loan and takes you 2 years to save up enough to pay it off, then so be it.

I would only take the home equity loan to repay the 401k loan in event of job loss.  I know with my company you have until 3 months after the end of the quarter where you lost your job to repay the loan.  So if you lose your job February 15th, you have until 3 months after March 31st to pay back the loan, which should be enough time to secure a home equity loan unless the bank plays games with you due to potentially still being unemployed at the time you apply for the home equity loan.  Such is the risk of taking a 401k loan in the first place, I suppose.  Plan B in that event could be weighing the cost of taxes and lost future gains versus the interest cost of putting it on credit card loans.  You just hope it never comes to that.

UnleashHell

  • Walrus Stache
  • *******
  • Posts: 6543
  • Age: 52
  • Location: Florida
  • Chapter IV - A New ... er.. something
Re: 401k loan repayment question.
« Reply #7 on: January 05, 2015, 01:53:03 PM »
The biggest advantage of doing a home loan is to get the money back into the market and earn a better return than 3.5% and all tax free.
If I saved up then I'd have to pay tax on the cash while saving and on any profit made investing.

the repayment is 400 a month. Lets say I saved an extra 500 a month until I have enough in savings to reduce the principle in full.
The 500 is a post tax amount.

The 401k loan is at 45k

taking a loan for 45k and setting the term so it equals a 400 payment means that I can switch 500 a month from savings into a 401k. with the added tax advantage thats a good chunk of change - add to that the 401k money from the loan is now fully invested into the market instead of me paying 3.5% to the loan account.


The way I look at it is that the extra I can earn just on the reinvestment of the loan balance will easily outwieght the disadvantage of paying a 3rd party for the loan. additionally I reduce my taxes by putting extra moeny into 401k's.

Or I can just tell my wife to get a better paying job :D

DoubleDown

  • Handlebar Stache
  • *****
  • Posts: 1989
Re: 401k loan repayment question.
« Reply #8 on: January 06, 2015, 08:48:48 AM »
I don't know how your exact 401k works, but doesn't your balance go up by $400 with every $400 loan repayment you make? That is, with every payment you likely are both paying down the loan balance (avoiding the 3.5% interest) and getting that money working for you again as an investment (at whatever return rate your 401k investments are getting). That's one reason why borrowing from a 401k provides kind of a double hit -- you take the interest charges plus lose the prospect of that money gaining returns while it's borrowed.

Taking a home loan to invest the money elsewhere provides no advantage, unless you just feel like doing extra margin investing. You could do that whether or not you had an outstanding 401k loan (or, if you could get some really ridiculous loan terms like 0.9% you could take advantage of arbitrage and pay off the 401k loan entirely with the lower rate home loan).

There's no magic formula here -- you just have to repay the loan at whatever pace works for you.

UnleashHell

  • Walrus Stache
  • *******
  • Posts: 6543
  • Age: 52
  • Location: Florida
  • Chapter IV - A New ... er.. something
Re: 401k loan repayment question.
« Reply #9 on: January 06, 2015, 10:27:12 AM »
Yes it does. And the interest is payable back to my account so no third party is getting their grubby little mits on it. From a best case scenario I can look upon it as a cash/bond that’s earning 3.5%, which enables me to be fully invested in stocks elsewhere.

However it also ties me to the company because I can only pay it off in full – or not at all if I want to leave.  Switching to a home loan gives me that freedom plus put my money working in the market which should earn a far higher (and tax free) return than the terms of the home loan.

27y/oTennesseeRetiree

  • 5 O'Clock Shadow
  • *
  • Posts: 49
Re: 401k loan repayment question.
« Reply #10 on: January 06, 2015, 11:13:28 AM »
Do you have $45k equity in your home? Why not open a no fee HELOC against it. Then you have options. If you leave your job you can use it to pay back the 401k loan. You don't have to worry about getting it if you are unemployed because you qualified for and got it when you were employed. It gives you options and peace of mind without costing a dime.

malligator

  • 5 O'Clock Shadow
  • *
  • Posts: 8
Re: 401k loan repayment question.
« Reply #11 on: March 03, 2015, 02:42:46 PM »
Sorry to resurrect and piggyback, but I'm in the same boat. I'm trying to pay down debt as quickly as possible and my 401k loan has me all sorts of conflicted. It's at 3.25% so I'm not freaked out by the interest (only the fact that my money isn't "working"). Mine also needs to be paid back in a lump sum.

I'm contemplating starting a (taxable) offset account at Vanguard. If my loan goes to term and nothing bad happens then I have a nice taxable account. If something unforseen happens and I need to leave my company or just need to pay off the loan for some reason I can use the offset account. The downside, of course, is that a taxable account in VTSAX may lose money. Maybe use Total Bond instead? Just save up and pay off the loan and forget this whole stupid offset account nonsense? lol

Thoughts/advice, anyone?

P.S. I'd still have a cash emergency fund. This offset account would be nothing but a hedge against the 401k loan.

Sid Hoffman

  • Pencil Stache
  • ****
  • Posts: 743
  • Location: Southwest USA
Re: 401k loan repayment question.
« Reply #12 on: March 03, 2015, 10:08:22 PM »
Sorry to resurrect and piggyback, but I'm in the same boat. I'm trying to pay down debt as quickly as possible and my 401k loan has me all sorts of conflicted. It's at 3.25% so I'm not freaked out by the interest (only the fact that my money isn't "working"). Mine also needs to be paid back in a lump sum.

I'm contemplating starting a (taxable) offset account at Vanguard. If my loan goes to term and nothing bad happens then I have a nice taxable account. If something unforseen happens and I need to leave my company or just need to pay off the loan for some reason I can use the offset account. The downside, of course, is that a taxable account in VTSAX may lose money. Maybe use Total Bond instead? Just save up and pay off the loan and forget this whole stupid offset account nonsense? lol

Thoughts/advice, anyone?

P.S. I'd still have a cash emergency fund. This offset account would be nothing but a hedge against the 401k loan.

Well since this topic is back up again, I too have a 401k loan that I took out last year when I found myself out of a home and in need of raising about $50,000.  I was able to raise some of the money by selling my car and liquidating stock, but the rest came from a 401k loan.  I myself have been living as cheaply as possible to get that loan repaid at the soonest point I can.  I see the biggest risk being that I leave my job, voluntarily or otherwise and then need to repay the loan or else lose a bunch of money to penalties, taxes at my marginal rate, and a bunch of money and potential future tax-free gains.

Mine is at 5.25% so you could argue that the motivation to pay is back is more urgent, but you could argue against such logic too.  Suppose my 401k loan had a 20% interest rate.  Would that really be so bad, considering the interest is paid to myself and 20% would be more than the market returns?  As I see it though, the 5.25% I'm earning on my 401k loan's outstanding balance is less than the 7% return of the stock market with reinvested dividends that I think is fair to expect over the next 4+ years of my loan balance.  So because of that, I view repayment of the loan as a way to get that money to work at 7% tax-free instead of merely 5.25%.

I think you should view yours the same way.  Your money could be statistically likely to return 7% if it were in the 401k again, but instead you're only getting 3.25% on your money due to the low interest rate of your 401k loan.  Meanwhile you've got that low interest rate but also the risk of the tax penalties, loss of opportunity, and so on.  You can do whatever's right for you, but for me personally, I'm looking to just repay mine as quickly as I can so the money is safely returned to the 401k tax shelter.