• We’re currently investigating an issue related to the forum theme and styling that is impacting page layout and visual formatting. The problem has been identified, and we are actively working on a resolution. There is no impact to user data or functionality, this is strictly a front-end display issue. We’ll post an update once the fix has been deployed. Thanks for your patience while we get this sorted.

Paying back loan from 401k early and tax considerations

Status
Not open for further replies.
IronWing

IronWing

No Lifer
Note: I haven't borrowed against the 401k yet, I'm trying to think about various scenarios.

I'm trying to figure out if I'm thinking about this correctly. If I have a loan drawn on my 401k I can pay it off early by writing a check to the trustee. What I'm thinking though is that I would probably be screwing myself as the 401k, the loan, and the regular payments on that loan are all using pre-tax dollars. Any pre-payments would be post-tax dollars. So I'm thinking I would be dinging myself by ~25% on the value of any pre-payments. Since the interest on the loan is being paid to myself there isn't a strong drive to pay off early other than the emotional appeal of being done with it. The funds I would borrow would come out of the very conservative portion of the portfolio so the interest I'd be paying myself isn't much different than the interest the money would be earning in the account. Is my thinking about the pre-tax vs post-tax aspect of pre-payment correct?
 
Did you look into whether you would be losing the company match until the loan gets paid back? For where I'm employed (and if I recall correctly, it was the same way with the last place I worked), that's 5% I'd be losing right off the bat until every cent of the loan gets paid back.
 
sandmanwake said:
Did you look into whether you would be losing the company match until the loan gets paid back? For where I'm employed (and if I recall correctly, it was the same way with the last place I worked), that's 5% I'd be losing right off the bat until every cent of the loan gets paid back.
Click to expand...


With my employer, the match would remain unaffected. I'll still be paying into the 401k at my regular rate which gets the full match. The loan payment would be in addition to the regular contributions.

On the tax side, I'm also thinking that right now I'm paying the mortgage with post-tax dollars. If I take out the loan from the 401k and pay off the mortgage I would be using pre-tax dollars so there would be a savings there. Because the amount of interest I'm paying on the mortgage is low, using the standard deduction is a better deal for me than itemizing so the current mortgage payments really are post-tax dollars.

The risk is that if I were to lose my job, I would have to pay back the 401k loan immediately or face a taxable distribution with penalty. My company has weathered the storm fairly well and has downsized all it is likely to downsize (through attrition, no layoffs) so I think my job is secure.
 
I too wonder this. I could pay off loans (student and otherwise) with my 401k, but haven't because of the possible negative financial aspects.

Although are you sure you're repaying your loan with post-tax dollars? I pay mine with pre-tax dollars, and that is the $ that would be going to the loan. Although I assume since you're talking about a mortgage the 5% of your pay (or however much you contribute) would take forever to repay the loan.
 
If you have a loan when you decide to leave your job and also want to cash in (not roll over) your 401k they just deduct the unpaid amount from the proceeds. Then the unpaid loan amount and the remaining disbursed funds are wholly taxable with a shiny 10% penalty to boot.
 
You have overthought this pre-tax vs. post-tax bit. You are considering moving money from your left pocket to your right pocket and back. As long as it goes back following the proper laws and regulations, there is no tax benefit or penalty. There is no 25% savings nor is there a 25% ding. Just scrap all that nonsense before continuing with this idea.

You correctly identified one risk - losing your job. At that point, you'll have no job, a much smaller retirement account (meaning you can't borrow from it in your time of need), in a jobless recession. Your only source of money would be from your home. But without a job, you might not get another mortgage on your home equity, so you might be left selling your house. No job, no house (and/or large tax penalty), and no retirement - that is your downside possibility.

What is your upside possibility? You might save a bit of money. You'll be giving up the gains from your investment but you'll be saving some of the money you pay to the bank. The net effect is not very big.

Small upside, large downside. That isn't a fair gamble.

The other risk that you are ignoring is volitility in the stock market. To make that small upside bigger, you correctly identified that you'll need to use your conservative portion of your investment portfolio. That by itself means your investment portfolio is suddenly off balance in much riskier position. In essence, you'll be shifting to all risky stocks at a market peak when there is massive unemployment (ie a good reason for the market to fall). In reality, you should be trying to rebalance more conservatively. Sell some stocks (lock in the recent gains) and buy more bonds (be safe for the possibility of another crash).

Which brings me back to the original gamble. If you are willing to risk your house and your retirement over a small possible gain, why go through all the hassle of a 401k loan? Why not just make your retirement account slightly riskier? That'll accomplish the same goal without all the added paperwork.
 
Dullard hits it on the head...again. But, one other thing, 401K loan repayments are generally made with after-tax money, not pre-tax. So there isn't any tax effect.
 
I believe he's alluding to the uncertainty of tax rates in the future. No doubt influenced by current going's on in DC. 😀
 
CPA said:
Dullard hits it on the head...again. But, one other thing, 401K loan repayments are generally made with after-tax money, not pre-tax. So there isn't any tax effect.
Click to expand...

Yeah, I've been rethinking that after realizing that if it worked the way I was thinking it did, it would drive down the tax owed on the income used to pay back the loan, and everybody would be doing it.
 
"You correctly identified one risk - losing your job. At that point, you'll have no job, a much smaller retirement account (meaning you can't borrow from it in your time of need), in a jobless recession. Your only source of money would be from your home. But without a job, you might not get another mortgage on your home equity, so you might be left selling your house. No job, no house (and/or large tax penalty), and no retirement - that is your downside possibility."

I realize this is an old thread, but I am currently looking at borrowing from my 401K to pay off my house. All I can say to the above quote is that I'd rather my home be free and clear with NO MORTGAGE AT ALL no matter what other financial straits I'm in. No one is going to kick you out of a house you own.
 
Alardt said:
"You correctly identified one risk - losing your job. At that point, you'll have no job, a much smaller retirement account (meaning you can't borrow from it in your time of need), in a jobless recession. Your only source of money would be from your home. But without a job, you might not get another mortgage on your home equity, so you might be left selling your house. No job, no house (and/or large tax penalty), and no retirement - that is your downside possibility."

I realize this is an old thread, but I am currently looking at borrowing from my 401K to pay off my house. All I can say to the above quote is that I'd rather my home be free and clear with NO MORTGAGE AT ALL no matter what other financial straits I'm in. No one is going to kick you out of a house you own.
Click to expand...

Stop paying taxes on it and see what happens.
 
Status
Not open for further replies.

TRENDING THREADS

Back
Top