Borrowing from 401K

[mousefanmichelle]

My dh did this to finance a truck for his business. He borrowed against his account. Monthly payment deducted out of his paycheck each pay and wha-la it's paid for. He wants to consider us doing this for our credit card debt. I don't know how I feel about it. I am glad this thread popped up so I can see who has done it and why and who wouldn't do it and why. I don't like the idea of it at all but I like the intrest rate 3% vs. 18% (I've tried to lower it and they won't budge).

 

[crisi]

My dh did this to finance a truck for his business. He borrowed against his account. Monthly payment deducted out of his paycheck each pay and wha-la it's paid for. He wants to consider us doing this for our credit card debt. I don't know how I feel about it. I am glad this thread popped up so I can see who has done it and why and who wouldn't do it and why. I don't like the idea of it at all but I like the intrest rate 3% vs. 18% (I've tried to lower it and they won't budge).

Think about your marginal tax rate at retirement added onto that 3% interest rate - that's the rate you are REALLY paying. Your credit card is cheaper.

 

[thomas998]

Every situation is different... there really isn't a one right answer.

A very large part of the decision is dependent on the way you have the money invested inside the retirement account. Some places are very limited in where the money can be and other aren't... you may be in a fund that has been be turning out 15% returns on a consistent basis for the past 5 years.... you could just as easily be stuck in investments that are making 5% in a good year or losing money in a bad year... only you know what type of investments your money is in... BUT if you aren't making super returns and realisticly expect to see a 5% return this year and are going to borrow money that you will pay back at 4.5%.... then what have you really lost... only .5% for a year. Even with compounding that isn't a huge hit...not nearly as costly as if you were in funds that had been delivering a 15% return. So first off look at how your retirement funds have done historically...

Second thought... remember that if you quit your job or are fired or leave for any reason, that you have to pay back the amount you borrowed. IF you don't you not only have to pay taxes on the amount you took out as if it were income, you also have to pay a 10% penalty on the amount that you had not yet paid back... So if you borrowed 10,000 and leave the company after only $5,000 had been paid back, you can pay the $5,000 back and suffer no impact... BUT if you can't pay it back because you don't have the money, then you would have to pay a penalty to the government of 10% ($500) plus at the end of the year you would have to claim $5,000 more in income for that tax year... if you were in the 25% tax bracket that would be $1250.... or added to your 500 penalty you would end up paying $1750..... AND you would lose the ability to put that $5,000 back into your retirement account.

As someone said, your retirement account is untouchable by creditors if you file bankruptcy... that isn't the case once you take that money out.

Frankly you should probably start out by being honest with yourselves... are you in such a deep hole that you can't get out right now... If you are, you should consider bankruptcy... probably not chapter 7 since your probably have assets you don't want to lose... but chapter 13 would allow for a re-structuring of your payments and likely lower or eliminate interest rates on your debt.... the following site will give you some info on this option.
http://www.bankruptcyinformation.com/personal-bankruptcy.htm

In the end... only you can make the right decision because you know what your situation is... blanket answer that you should borrow or shouldn't are pretty useless since none of us know all the details about your situation.

 

[thomas998]

Think about your marginal tax rate at retirement added onto that 3% interest rate - that's the rate you are REALLY paying. Your credit card is cheaper.

Actually a married couple filing jointly and on retirement income would likely be in the 15% tax bracket (under the current tax code)... so in your calculation it is a wash 15% plus 3% is 18%.

 

[a1tinkfans]

Sorry to hear that you are in a bind.

I actually went against convention and pulled from a 401K years ago, took a loan against it for just 10K and had a Pool installed, I know, I know, but I REALLY wanted the pool and said I would just pay it back with interest, too ME. It really was no big deal for me, just had it taken from my paycheck each week. No real "ramifications"

I DO recall when I left the company to move elsewhere I had to pay back the loan within 30 days of leaving. Fortunately for me I was prepared for this and with a REALLY big bump in salary it was not an issue.

Despite this, I would not "jump" at taking a loan unless you are fairly certain that you will be able to pay it back to avoid issues down the line. So many people that never thought they'd be downsized, suddenly without a job, SCARY!

I would strongly suggest speaking with HR at work and also having a real heart to heart with DH to figure out what is best for your family, sometimes tough decisions are necessary.
I can empathize my DH was hurt years back, out of work about 8 mos, really wiped out our savings, not an easy time, but we also knew that eventually with "tightening" the finances we'd tough it out. It was not easy, but We did successfully!

We're very blessed to be where we are financially and health wise as well.
I wish you the very best. You'll get thru this!!!

 

[santa's surpriz]

I have a very strong opinion on this subject! Do not do it! If you do not pay it back in a specific amount of time, there are very high penalties plus what everyone else has said. Each case is different though, depending on alternative options. You also have to consider if some thing happened how it would affect taxes, etc. If you were not able to pay back, how long and how would you replenish your retirement. We need alot more money to survive future retirements years than our parents and grandparents did.

You would be better off consolidating debt thru a home equity product. This will give you the best rate and tax benefits to get some of the paid interest back. Depending on the amount of equity and debt you may want to considering refinancing. If your mortgage rate is 7 percent or above, now may may be the perfect time to refi w. cash out to pay off the debt.

Another good option is a CD secured loan. If you can or have a family that can do this for you. They basically pledge their money for your loan, still earn their interest. You pay back the loan, when the loan is paid off the CD hold is released. They do not have to be an obligator on the loan. You can get a decent interest rate and pay off your debt in a resonable amount of time.

You can also look into an unsecured loan, depending on the amount and your credit and debt to income percentages. Rate may be higher, but you can still pay it off faster and save money.

Whatever you do, DO NOT SEEK A DEBT CONSOLIDATION AGENCY/PROGRAM!!! They steal your money, you pay them an inflated amount to cover so costs instead of paying your cards included in the program. Most of the time they do not use that money to pay towards your debt for you. Instead it is used to cover their costs of participating. They negotiate for a settled amount....however they have no leverage to negotiate until after your accounts are charged off and your credit is completely destroyed. A little known fact is that the negotiated credit card company can 1099 for the amount that you did not pay back. (Example:10k credit balance is settled for 7500, you pay 7500, the remaining 2500 could be 1099'd and you would end counting it as earned income and taxed on that amount. YUK.) Realistically you could be in one these programs for as long as it could take to pay off the credit card debt in a traditional method, in the interim your credit could be destroyed and you still have to rebuild it. In a nut shell it could take 7+ years to finish the program, it will be nearly impossisble to get credit for a car or anything else if you needed it. Then you will have to spend appx. another 7 years or so to repair and rebuild your credit.

I work in banking, there are other solutions. Please seek the advice of an experienced, trusted banker that may be help you. If you have questions about how any of the above work and more information, please PM me. I will be more than happy to help you!

 

[MaryKLady]

I don't ever touch my retirement savings. I deposit $ and forget about it. I would have to be in a very serious bind and some cc debt isn' the kind I mean. If you have good credit, what about balance transfers until you can pay it off. A lot of cards have great introductory offers and can save you the interest.

I hope you can find some helpful ideas here. Good luck to you.

 

[Kathi OD]

401ks aren't taxed on withdrawl either, that isn't where HayGan is getting the double tax.

Let's say I take out $10,000 from my 401k as a loan - I won't be taxed on that loan.

Now I pay it back - with after tax income - so - lets say thats a 25% tax rate - I have to earn $12,500 to pay that money back - and I now have that $10k back in my 401k.

Now when I retire and take money out of that 401k, I pay taxes on it - because I supposedly didn't earlier. There is no provision for "except for this money here which we already taxed." So I'm still at that 25% bracket (just to make things easy) and need $10k, I have to take out $12,500.

So the government has gotten $5000 from me in taxes when if I hadn't borrowed they would have only gotten $2500.

Thats a pretty heavy penalty.

Crisi, thanks for the explanation! I completely understand what PP meant now.

 

[PelletierBears]

I'm able to "calculate the future cost" of taking a loan from my 401k and it doesn't have as big an impact as you'd think years down the road (depends on the amount taken out). You should check and see if your plan administrator has a web site where you can do the same and decide if it's worth it to you. I took a small loan (under $5000) from my 401k and it worked out great. Only you can weigh the pros and cons based on your current situation. Sometimes peace if mind alone makes it well worth it. I'm sure you and your husband are under a lot of stress and easing your financial hardship makes sense if you can do so. I will say though that if there's a chance of a near future layoff from your job, etc that you don't do it. As others have advised, you have to pay back the loan to avoid being taxed which adds up to quite a bit. Good luck whatever you decide.

 

[robsmom]

401ks aren't taxed on withdrawl either, that isn't where HayGan is getting the double tax.

Let's say I take out $10,000 from my 401k as a loan - I won't be taxed on that loan.

Now I pay it back - with after tax income - so - lets say thats a 25% tax rate - I have to earn $12,500 to pay that money back - and I now have that $10k back in my 401k.

Now when I retire and take money out of that 401k, I pay taxes on it - because I supposedly didn't earlier. There is no provision for "except for this money here which we already taxed." So I'm still at that 25% bracket (just to make things easy) and need $10k, I have to take out $12,500.

So the government has gotten $5000 from me in taxes when if I hadn't borrowed they would have only gotten $2500.

Thats a pretty heavy penalty.

There are many reasons not to borrow the money but i think the double taxation is a rumor that is not mathematically correct.

You end up in the same tax situation either way. When you take the 10,000 you get to buy something worth 10,000. If you had not put the 10,000 in your 401 you would have paid taxes and put it in the bank but only had 7500in the bank. You would have to come up with 2500 more to buy what you want. yes you pay back with 10,000 that was 13,000 before taxes, but if you had never used the 401 you would have had to earn 13333 to come up with the 10,000 you need anyway.

Let's say I earn 23,333. I put 10,000 in my 401K, i pay no taxes on the way in. On the other 13,300 i pay 25% which leaves me with 10,000 in the bank.

now i decide that i want to buy something that is 10,000. I can spend the 10,000 in the bank. later when i take the 10,000 out of my 401 I will pay the 2500 in taxes on that and be able to buy a 7500 item. So the 2 items cost me 2500+3333 (5833) in taxes.

In option 2 i earn 23,333 and do the same thing putting 10,000 in 401 and paying 3333 in taxes to have 10,000 in the bank. Later, i decide to buy something but i use a loan and take the 10,000 from my 401K i pay it back with the 10,000 that i had in the bank. I still have 10,000 in the 401k. when i take that out later i pay 2500 in taxes. Again I have the same 2 items and paid the exact same tax of 5833. (2500+3333).

In option 3 i earn 23,333 and put none of it in a 401. I pay 25% in taxes which is 5388. I am left with 17500 to buy my 10,000 and 7500 same 2 items.

Ignoring interest and inflation, there is no double taxation to using a 401K loan.

 

[SuzanneSLO]

You are not paying additional taxes on the principal you withdraw and then must return to your retirement account. For example, if you borrow $10,000 and pay it back the next day, you will not have to pay back any interest and will not need to earn any additional moeny to pay that amount back. Of course, you will still have the $10,000 in credit card debt, so taking the loan and immediately returning it doesn't help that problem.

The bottom line is if you have $10,000 in debt to your retirement plan or to your CC, you need to earn more than $10,000 to have enough after tax money to pay off that debt.

Where you do need to earn more money is to pay the interest on the retirement loan. For example, if the interest rate is 6% and your tax rate is 25%, you will need to earn $600 plus an additional $200 to have enough after tax income to pay 1 year's interest. In contrast , with CC debt at 18% you will need to earn $1800 plus $600 to pay one year's interest on that debt.

Let's say you retire immediatley after you have paid back your retirement loan, with your account balance equal to $10,600. If you are still in the 25% tax bracket, you will need to pay $2500 on your $10,000 initial retirement investment. This is no different than if you had not taken a loan.

You also need to pay $150 on $600 of earnings withdrawn as well. So for the $800 your earned to pay interest into the retirement account, you will only have $450 after tax, a loss of $350.

You have also lost the earnings on the retirement money for the term of the loan, lets say a guranteed 5% return equalling another $375 after taxes lost.

But compare this to the credit card payment, where you needed $2400 in earnings and have lost all of that money. But in this case, without the retirement loan, your retirement account went up and you will have $375 in after tax income.

Borrowing form a retirement account may still not be the right thing for the OP, but at least she should work with the right calculations. -- Suzanne