would like some opinions on this please

I currently have a sizable 401k that is entirely invested in a (low-cost) stable value fund (think short term bonds). The equity investment funds available in the 401k are all high fee (>1%) with no index options, so I park the balance in the low fee stable value and use it as the cash/short-term bond portion of our asset allocation.

The interest rate on a 401k loan is 4.125%. Taking a loan does not affect ability to contribute to 401k, which I max every year due to being in highest tax bracket. My job is stable and I have no plans to leave it in the near future. If I were to get laid off I would receive a huge severance package as well as deferred comp that vests immediately, so I would easily be able to pay off any 401k loan balance and have a big amount left over.

We have various fixed rate mortgages on investment properties, the highest being 4.625%. We also have many taxable accounts with large balances fully invested in equity index funds. Given the current 0% rate environment, I try to keep as little cash as possible, except in the 401k due to the lack of low cost investment options.

The question I have is, does it make sense to take a loan on the 401k at 4.125% and use proceeds to pay down the highest rate (4.625%) mortgage? I figured that since the 4.125% 401k loan interest would be paid to myself, using loan proceeds to pay off higher rate debt would make sense since I have no plans to invest the 401k balance in anything other than cash-like equivalents, and have no concerns about ability to repay the loan if my employment situation were to change.

Are there any other considerations I am missing? One thought was that the interest I pay myself which accrues in the 401k account would be paid with after-tax dollars, but would then again be taxed upon eventual withdrawal - is this correct?

Thanks in advance

The "interest rate" on the 401k loan is irrelevant. In most 401k plans, this "interest" is fully repaid into the 401k. So, effectively, you are paying yourself from your checking out into your 401k at some amount... 4.125% of what you withdraw from the 401k in this case.

In order to determine if this is good/bad, you have to look at it from a Net Worth perspective... meaning, "how does my overall asset and liability picture change as a result of this."

To simplify, let's assume this is a 1 yr loan of $10,000 from the 401k (you can change the amounts, but the point will be the same).

Your current situation:

- some income level at a 25% marginal total tax rate

- 10k 401k "loan" @ 4.125%

- existing mortgage @ 4.625%, let's call it 200k outstanding (the amount is only relevant to calculate your net of income tax mortgage rate, because it will change every year if you decide to repeat this)

- 80k gross taxable income (net of all pre-tax deductions... HSA, 401k ,whatever)

Before we get started, let's clarify that the "net" mortgage rate will be different for everyone. For this example, you can deduct ~9.25k as a mortgage interest deduction... assuming you itemize. Note that this benefit will be gone before the mortgage is paid off, because the std deduction will be higher once the mortgage interest reaches ~6k/yr. So, the tax savings in this given year will be 9.25k - 6.2k (std deduction for single status), so a net tax savings of 3.05 x .25 = $762.50 when you file taxes. In the current year, that means you are effectively paying $8,487.50 in mortgage interest after tax... or an effective net of tax mortgage rate of 4.24375%. Some people mistakenly think the entire amount is a deduction... technically, it is, but we all get the std deduction anyway... so

**it's most accurate to only consider the marginal benefit over the std deduction when calculating your net of income tax mortgage interest rate.**Afterwards, you earn money on your 80k pre-tax salary. Whether you had a loan outstanding to yourself or not, you would pay the same amount of taxes here. So, it doesn't matter. What effectively changes is that you will accelerate paydown on a net of tax mortgage @ 4.24375% (above). Whether the cash is coming out of your 401k or not doesn't really matter. If you prefer to lock in a return of 4.125% into your 401k for the 10k, then so be it, but you are just transferring the money in your checking account to your 401k. Deduct from checking, add to 401k.

**Net worth is flat from the "401k loan" payment alone!**Of course, there are usually fees associated with taking out the loan, and also the case of whether or not you want to accelerate payment on a 4.24375% mortgage debt (4.625% nominal rate). That's a different story entirely.

In my view, the only reason to take out a "401k loan", is if you are short on cash and want to aggressively pay something off. A 4.625% mortgage is likely not a huge benefit. If you had credit card balances at 15%, then maybe you should consider it. Again, you're not "paying" anything to yourself. That rate of the 401k loan is just a transfer from checking to the 401k. The savings is by accelerating payoff of the debt itself. In the above example, the payer will save 10k @ 4.24375% (net of income tax mortgage rate) so ~$424.38 in the first year.

To clarify, that is the explicit savings. Other alternatives will make the decision very different, as it is based on many different assumptions:

- expected return in 401k investments

- expected return on taxable investments

- expected future interest rates

- other outstanding debts and related interest cost

- liquidity available from other sources

... and so on.

From a net perspective, and not including assumed rates of return, the only "savings" is the saving of mortgage interest. The rest is a decision on how aggressively you'd like to become debt free, and the expected return on your various investments and your liquidity costs.

Short answer: You only save the mortgage interest. The rest is paid from yourself... to yourself (from checking account cash to 401k). You'll have to consider the opportunity costs separately... as that is a very different and highly judgmental process.

Hope that helps.