quick finance question - 401k

[ViviTheMage]

I've got a decent chunk of money in my 401k ... and found out I can take out a loan against it, and pay back the loan, paying interest (which goes 100% towards my 401k). I have a car loan, so I could just take a loan out from my 401k..and pay back my 401k, and the interest towards my 401k instead, is this a good idea?

Sounds like it is...haha. That way my interest doesn't go to the bank, goes back to me!

 

[corwin]

I just did this myself and personally think it is, there are some downsides when you finally take a payout but they aren't too major, and most likely you'll be paying yourself a lower interest rate than what you were to the bank even...it's a definite win in my book

 

[ViviTheMage]

AFAIK there is no cost to take a loan against myself. my 401k is pretax, so I assume i'll be taxed?

 

[Capt Caveman]

Someone else will jump in with a better answer but I'm pretty sure that even though it sounds like a good idea, it's actually not b/c the money withdrawn is not allowed to grow.

 

[Schfifty Five]

I could have sworn you made this exact thread before...or it not you, someone did.

 

[ViviTheMage]

I don't recall one, and it wasn't me!

 

[dullard]

There are several drawbacks.

The most obvious drawback is that instead of earning 8% or 10% or whatever on your money, you are now only earning whatever interest you pay yourself. This might seem like a minor point, but losing a little money in your 401k now will exponentially become a major loss for you by the time you retire. The benefits of the tax-deferred plans should not be underestimated. Do the math.

But there are many subtle drawbacks. Just one example is that you'll most likely have to pay the loan 100% in full if you quit or are fired. Do you honestly have enough money to pay off that loan in full when you have no income? If the answer is yes, then you don't need the loan. If the answer is no, then you'll be in a very painful situation if you lose your job. You'll have no job, have to pay back a loan that you can't pay back, and if you don't you'll owe massive tax and penalities that you also can't afford.

The alternative is to just get a better car loan. No drawbacks there.

 

[corwin]

AFAIK there is no cost to take a loan against myself. my 401k is pretax, so I assume i'll be taxed?

No you're not taking a distribution just a loan, so you're not taxed...there is usually a small fee (mine was $75) charged but otherwise that's it...when you finally reach retirement age there is another small tax added on to the interest you pay back in but that's the only real downside, that and losing whatever you may have earned against the amount while you have the loan out, which right now isn't much, you're probably giving yourself a better return than you would get in the markets

 

[her209]

AFAIK there is no cost to take a loan against myself. my 401k is pretax, so I assume i'll be taxed?

There's usually a small loan processing fee. You won't be taxed on the amount you take out as a loan. But you will be paying back the loan with after-tax dollars.

 

[corwin]

The most obvious drawback is that instead of earning 8% or 10% or whatever on your money, you are now only earning whatever interest you pay yourself.

Who's getting 8-10% these days?

Just one example is that you'll most likely have to pay the loan 100% in full if you quit or are fired. Do you honestly have enough money to pay off that loan in full when you have no income? If the answer is yes, then you don't need the loan. If the answer is no, then you'll be in a very painful situation if you lose your job. You'll have no job, have to pay back a loan that you can't pay back, and if you don't you'll owe massive tax and penalities that you also can't afford.

This is definitely correct though, if you leave you will have to pay it back or pay the taxes and penalties on it as a distribution

 

[dullard]

Who's getting 8-10% these days?

I just invested a good chunk into mutual funds in August and have gotten 10% in just 1 month. Of course that won't continue, but with proper strategies, it isn't that hard to make money.

The stock market is still down. It is the right time to be invested / get more investments.

 

[Elganja]

penfed, for both new or used (refinance):

[SIZE=+1]1.99[/SIZE]% APR†
12 to 48 months
$10,000 - $70,000

and it's easy as pie to join

 

[ViviTheMage]

I don't plan on leaving, worst case take out a loan against my car, and pay back my 401k?

What other tax implications do you speak of?

 

[corwin]

I just invested a good chunk into mutual funds in August and have gotten 10% in just 1 month. Of course that won't continue, but with proper strategies, it isn't that hard to make money.

1 month doesn't count...and most people aren't spending a ton of time going in and manually managing their accounts to try to maximize here and there, the vast majority pick an investment "style" from the provider and let it ride...

 

[dullard]

1 month doesn't count...and most people aren't spending a ton of time going in and manually managing their accounts to try to maximize here and there, the vast majority pick an investment "style" from the provider and let it ride...

1) I said "or whatever", choose any number you want, it'll still likely be more than the car interest rate with interest rates near 0%.

2) With stocks down now, picking a style now and letting it ride will very likely do well. 10% would not be out of the question at all in next year starting now. You'd have a point if S&P were at 1400, but at 1200, your ideas are not as valid.

 

[ViviTheMage]

1 month doesn't count...and most people aren't spending a ton of time going in and manually managing their accounts to try to maximize here and there, the vast majority pick an investment "style" from the provider and let it ride...

That's what I do....super risky. I am 24, so I am not too worried.

 

[corwin]

What other tax implications do you speak of?

That amount will be taxed differently when you take it at retirement

 

[Capt Caveman]

I don't plan on leaving, worst case take out a loan against my car, and pay back my 401k?

What other tax implications do you speak of?

Interest rates are so low, you're better off just getting a car loan and not having to deal with all of the complications.

 

[dullard]

I don't plan on leaving

Can you honestly say there is 0% chance of being fired, laid off, finding a better job, etc?

 

[Capt Caveman]

Who's getting 8-10% these days?

I'm doing better in the last 1yr, 5yr, 10yr, etc. YTD is a different story.

 

[ViviTheMage]

Can you honestly say there is 0% chance of being fired, laid off, finding a better job, etc?

no

guess I could just refi the loan...it's at 3.9% already, got it 2 years ago.

 

[richardycc]

other than what others have mentioned, the biggest thing is that the amount could be taxed twice, since you are paying back the loan with post-tax money, and when you take it out at retirement, it will be taxed again.

 

[ViviTheMage]

what's tax on it usually?

 

[thegimp03]

I've read stuff that says withdrawing from a 401k prior to retirement should be a last resort.

 

[dullard]

Here is the math:
Assuming 35 years until retirement.
Assuming 3 years left and $10000 left on car loan at 3.9%.
Assuming you pay off the 401K loan at the same monthly payment as the car loan.

10% return over the long haul:
If you left $10,000 it in the 401k, it'll become $326,386
If you used the 401k to pay off the car loan, it'll become $298,194
You lose $28,193 with your idea (but that is taxed, so it is a bit less than it sounds).

6% return over the long haul:
If you left $10,000 it in the 401K, it'll become $81,236
If you used the 401K to pay off the car loan, it'll become $78,720
You lose $2,515 with your idea (but that is taxed, so it is a bit less than it sounds).

Even if you get low returns on your 401k, you still come out ahead by NOT using it as a loan. And you don't take risks. And like Elganja posted, you can refinance the car loan to something that is so near 0% that it isn't worth bothering with your 401k.

And one more potential risk: borrowing from yourself can be addictive. Suddenly without a car loan, you might get a new TV, get a new house, etc. Each time borrowing from yourself. But then, when you retire, you realize you have a bunch of old crap and an empty 401k. This might not apply to you, but I post it as a warning for others.