401K Loans

[minnesotapaintlady]

When you borrow from your 401K what happens to the funds?  Do you actually borrow the money in there and it disappears from your account or are you borrowing against it?  When I was young my mom had a CD at the bank that I could borrow against whenever I wanted, so if I needed a car (or horse barn, LOL), I would just take a loan secured against it and paid 1% more than the CD was paying as an interest rate on the loan.  I'm guessing that's not how 401K loans work though? 

Looking for options to get some long overdue house repairs taken care of next year.

[ners]

The funds come out of your account.  You pay the money back with interest.  The amount of interest is based on your plans document. If you leave your job before the loan is paid back and you cannot pay the loan back it becomes a taxable withdrawal.  

[minnesotapaintlady]

Well, that definitely makes them less appealing.

[Rukh O'Rorke]

Nov 4, 2022 20:53:04 GMT -5 minnesotapaintlady said:

Well, that definitely makes them less appealing.

you'd be selling low!!!

[minnesotapaintlady]

Nov 4, 2022 21:59:48 GMT -5 Rukh O'Rorke said:

Nov 4, 2022 20:53:04 GMT -5 minnesotapaintlady said:

Well, that definitely makes them less appealing.

you'd be selling low!!!

Maybe.  We're talking about at least 8-9 months from now.

[tallguy]

Nov 4, 2022 20:53:04 GMT -5 minnesotapaintlady said:

Well, that definitely makes them less appealing.

Yeah.  Generally for most people and in most situations they are a really bad idea. 

[minnesotapaintlady]

Nov 4, 2022 22:28:02 GMT -5 tallguy said:

Nov 4, 2022 20:53:04 GMT -5 minnesotapaintlady said:

Well, that definitely makes them less appealing.

Yeah.  Generally for most people and in most situations they are a really bad idea. 

I'm just so retirement account poor from putting 50-60% of my income in for the past 5 years.  It sounded more appealing than pulling Roth contributions.

I have holes literally the size of basketballs in my siding now.  It really needs to be taken care of.

[tallguy]

Nov 4, 2022 22:32:12 GMT -5 minnesotapaintlady said:

Nov 4, 2022 22:28:02 GMT -5 tallguy said:

Yeah.  Generally for most people and in most situations they are a really bad idea. 

I'm just so retirement account poor from putting 50-60% of my income in for the past 5 years.  It sounded more appealing than pulling Roth contributions.

I have holes literally the size of basketballs in my siding now.  It really needs to be taken care of.

Find another way, even if it is merely stopping your current contributions.  It depends on the plan, but some plans stipulate that you cannot make additional contributions until the loan is paid off anyway.  Also, you will be repaying the loan with after-tax money.  It is not as simple as having them take the money out pretax as they do for contributions.  Definitely look into all of the issues involved before you consider it further.  And no, I would not recommend taking money out of Roth either.  I consider mine the most important money I have, and time only increases that.  

[CCL]

Any chance you could borrow against your mom's cd again? Or what about a home equity loan/line?

Could you get some of the neighbors, friends or family to help with it? Do it yourself to save on labor costs? I've put vinyl siding on a mini barn myself. It's not that hard, although a whole house would be a LOT more work.

I know you don't want to decrease retirement contributions due to the tax benefits.

[alabamagal]

I’ve done 401k loans (my YM card was taken away long ago!). I’m not as down on them as others, you just have to know the risks.

The plan will sell assets to generate money for the loan. You may be able to choose which assets to sell. If not you can rebalance after loan is taken out. Then you pay back with interest and rebuy your assets. You may be able to choose which assets you buy. Interest should be pretty low, and you are paying the interest to yourself. But you lose out on the gains in your assets during the loan. With market down now, and hopefully going up, that could be an issue.

If you are planning to stay with your job and pay it off it can work out. But s**t happens. I lost my job unexpectedly after taking a loan, and was prepared to pay it off to avoid taxes, but then found out my plan allows me to continue to pay off the loan directly to 401k provider, so that is what I do. I think of that payment as just part of my retirement contribution. We used the loan for a very specific one time issue.

If you can do home equity loan, that might be better option based on current market, but you should still consider all options.

[Deleted]

Nov 4, 2022 20:48:17 GMT -5 ners said:

If you leave your job before the loan is paid back and you cannot pay the loan back it becomes a taxable withdrawal.  

This was the dealbreaker for me, too, although apparently some plans now allow you to keep making payments.  Even if you leave because they "eliminate your job", some plans require that you pay them back or it's taxable.  Fortunately the one time that happened to me I was given a 6-month severance bonus that was way more than what I needed to pay it back.

[bookkeeper]

DH and I took out a 401k loan back in the 1990's.  We were 30 somethings with two small kids and moved 120 miles to take a new job.  Our old house took 6 months to sell.  We were getting out bid on houses at the new location by cash buyers.  We hit the pause button and rented a house for two years.  When we were ready to try and buy again, we took a 401k loan of $20,000 and put it in the savings account to buy a house with.  

That did the trick, we had down payment and closing cost money to work with.  DH had a 5 year payback on his loan.  We moved for work again after 3 years and DH was able to keep making the payment when he changed jobs.

The interest rate was low and borrowing our own money worked in this situation.  We sold the house at a profit and never had to borrow from our retirement funds again.  It worked out for us.

[minnesotapaintlady]

Nov 4, 2022 23:03:35 GMT -5 CCL said:

Any chance you could borrow against your mom's cd again? Or what about a home equity loan/line?

Could you get some of the neighbors, friends or family to help with it? Do it yourself to save on labor costs? I've put vinyl siding on a mini barn myself. It's not that hard, although a whole house would be a LOT more work.

I know you don't want to decrease retirement contributions due to the tax benefits.

I doubt my mom still has the CD...that was 30+ years ago.  I do have a 30K HELOC though, just not sure 30K will do it!  My house is really big (with attached 3 car garage that would have to be done too) and I doubt I can do vinyl here, unless they have some new product that is more durable.  It gets very windy up here sometimes, so most houses have some sort of hardboard or steel.

I am contemplating finding out if they could just do the south side of the house with something that matches.  That's really the only part that is really bad, the bottom 1/4 on the North side around the lower windows has rotting too and I'm considering bricking that.  They were going to when I built and I decided against it to save money.

The West side is still perfect....

[minnesotapaintlady]

Nov 4, 2022 22:57:12 GMT -5 tallguy said:

Nov 4, 2022 22:32:12 GMT -5 minnesotapaintlady said:

I'm just so retirement account poor from putting 50-60% of my income in for the past 5 years.  It sounded more appealing than pulling Roth contributions.

I have holes literally the size of basketballs in my siding now.  It really needs to be taken care of.

Find another way, even if it is merely stopping your current contributions.  It depends on the plan, but some plans stipulate that you cannot make additional contributions until the loan is paid off anyway.  Also, you will be repaying the loan with after-tax money.  It is not as simple as having them take the money out pretax as they do for contributions.  Definitely look into all of the issues involved before you consider it further.  And no, I would not recommend taking money out of Roth either.  I consider mine the most important money I have, and time only increases that.  

Stopping contributions would be worse for me as I get a huge kickback in tax credits for them.  Although stopping Roth is an option. 

You're not really paying back the loan with after tax money though, you're returning money that you didn't pay taxes on to begin with.  Although I guess that's true for the interest portion.

[minnesotapaintlady]

Just read my plan summary (boy is that some dull reading).  Our plan does not allow repayment to continue after termination unless the termination is due to a merger or acquisition, so it would be due immediately or considered a non-qualified withdrawal.  I'm not super concerned about losing my job in the recent future though...unless I walked out!  I've been there almost 30 years and we have a two year backlog of work right now.

eta:  I also turn 55 in about 15 months...I wonder how that would play into it since I would be allowed to take distributions at that point anyhow.

[tallguy]

Nov 5, 2022 9:56:56 GMT -5 minnesotapaintlady said:

Nov 4, 2022 22:57:12 GMT -5 tallguy said:

Find another way, even if it is merely stopping your current contributions.  It depends on the plan, but some plans stipulate that you cannot make additional contributions until the loan is paid off anyway.  Also, you will be repaying the loan with after-tax money.  It is not as simple as having them take the money out pretax as they do for contributions.  Definitely look into all of the issues involved before you consider it further.  And no, I would not recommend taking money out of Roth either.  I consider mine the most important money I have, and time only increases that.  

Stopping contributions would be worse for me as I get a huge kickback in tax credits for them.  Although stopping Roth is an option. 

You're not really paying back the loan with after tax money though, you're returning money that you didn't pay taxes on to begin with.  Although I guess that's true for the interest portion.

The problem with the 401k loan is that any amount repaid is not considered a contribution, and you do not get a tax break for it.  So yes, it is considered after-tax money.  You will also be taxed again when that money is distributed, resulting in the eventual double taxation of any amount required to repay the loan.  You would lose the tax break you are receiving either way.  If you stop contributions, you are then being taxed on that money instead.  If you repay a loan, you don't get the tax break on that money in the first place since it is not a contribution.  Yes, you are returning money that you didn't pay taxes on, but you are using money that you do pay taxes on to do it.  I'm guessing now would be a particularly inopportune time to do it, since the other real cost of a 401k loan is the opportunity cost of not being invested.  The market is down currently, so when it recovers you lose that growth as well.    

[tallguy]

Nov 5, 2022 11:07:57 GMT -5 minnesotapaintlady said:

Just read my plan summary (boy is that some dull reading).  Our plan does not allow repayment to continue after termination unless the termination is due to a merger or acquisition, so it would be due immediately or considered a non-qualified withdrawal.  I'm not super concerned about losing my job in the recent future though...unless I walked out!  I've been there almost 30 years and we have a two year backlog of work right now.

eta:  I also turn 55 in about 15 months...I wonder how that would play into it since I would be allowed to take distributions at that point anyhow.

Taking a distribution would be the same as stopping contributions, wouldn't it?  If you are contributing $20,000 and taking a taxable distribution of $20,000 you end up in the same place as not making a contribution in the first place.  Getting an employer match would change it a little bit.


  I would suggest "near future" rather than "recent future."  

[minnesotapaintlady]

Nov 5, 2022 12:12:43 GMT -5 tallguy said:

Nov 5, 2022 11:07:57 GMT -5 minnesotapaintlady said:

Just read my plan summary (boy is that some dull reading).  Our plan does not allow repayment to continue after termination unless the termination is due to a merger or acquisition, so it would be due immediately or considered a non-qualified withdrawal.  I'm not super concerned about losing my job in the recent future though...unless I walked out!  I've been there almost 30 years and we have a two year backlog of work right now.

eta:  I also turn 55 in about 15 months...I wonder how that would play into it since I would be allowed to take distributions at that point anyhow.

Taking a distribution would be the same as stopping contributions, wouldn't it?  If you are contributing $20,000 and taking a taxable distribution of $20,000 you end up in the same place as not making a contribution in the first place.  Getting an employer match would change it a little bit.


  I would suggest "near future" rather than "recent future."  

I meant if I was forced to due to job loss.  I wouldn't take a distribution while working, I don't think our plan allows it anyhow.

Right now I get $200 per $1000 contributions Federal and $100/$1000 State on top of my marginal rate and the 4% match on any contributions over about 5K.  2024 is probably the last year I'll have two qualifying children for that perk though, then it won't kick in except for contributions over about 10K.

[minnesotapaintlady]

Nov 5, 2022 12:05:58 GMT -5 tallguy said:

Nov 5, 2022 9:56:56 GMT -5 minnesotapaintlady said:

Stopping contributions would be worse for me as I get a huge kickback in tax credits for them.  Although stopping Roth is an option. 

You're not really paying back the loan with after tax money though, you're returning money that you didn't pay taxes on to begin with.  Although I guess that's true for the interest portion.

The problem with the 401k loan is that any amount repaid is not considered a contribution, and you do not get a tax break for it.  So yes, it is considered after-tax money. 

But you already got the tax break on that money.  Of course you don't get it again.  If you take a 10K loan you have an extra 10K of tax-free money to do whatever you want with. If you turned around and lump sum paid it off the next day from the proceeds would you still consider it after-tax money?

Again, the interest is a different story, but if I got a HELOC I'd be paying that interest with after tax money too.

[NastyWoman]

Nov 4, 2022 22:57:12 GMT -5 tallguy said:

Nov 4, 2022 22:32:12 GMT -5 minnesotapaintlady said:

I'm just so retirement account poor from putting 50-60% of my income in for the past 5 years.  It sounded more appealing than pulling Roth contributions.

I have holes literally the size of basketballs in my siding now.  It really needs to be taken care of.

Find another way, even if it is merely stopping your current contributions.  It depends on the plan, but some plans stipulate that you cannot make additional contributions until the loan is paid off anyway.  Also, you will be repaying the loan with after-tax money.  It is not as simple as having them take the money out pretax as they do for contributions.  Definitely look into all of the issues involved before you consider it further.  And no, I would not recommend taking money out of Roth either.  I consider mine the most important money I have, and time only increases that.  

that sounds a lot like setting yourself up for double taxation as the repaid money will go i to a tax deferred account and is subject to taxation upon withdrawal. Or is there a mechanism to work around this in place?

[minnesotapaintlady]

Myth 3: You'll pay taxes twice.
Morningstar Tax Webinar
Webinar
Down Market Tax Strategies


This assertion has been widely debunked, but I still hear it surface here and there: You've put pretax dollars into your 401(k), but you pay back your 401(k) loan with aftertax dollars; you'll owe taxes on that money again when you pull it out during retirement. Therefore, double taxation!

However, that statement greatly exaggerates the tax costs of taking a 401(k) loan; the only money "taxed twice" in the transaction is the interest paid. Meanwhile, the 401(k) borrower is able to take the loan, consisting of money that has never been taxed, without tax consequences.

Say, for example, I borrow $10,000 from my 401(k) on Tuesday, because my sister needs a loan until she receives a commission check on Friday. I'll pay no taxes on the amount that I borrow, and when she pays me back I'll put the $10,000 right back into the account without any tax consequences. The only aftertax money involved in the transaction--and that I'll also owe taxes on again in retirement--is the paltry amount of interest I owe for the three days I had the loan out.

Of course, from a practical standpoint investors often pay back their 401(k) loans with aftertax dollars, in contrast with my example above. Say, for example, I borrow $25,000 from my 401(k) to buy a car. The money I've borrowed tax-free from my 401(k) is sunk in my car and I can't get it out to pay myself back; to pay back my 401(k) loan, I have to use aftertax dollars. But I took the initial $25,000 out tax-free, so it's a wash from a tax perspective; I got a tax break on the amount I borrowed, but that break is effectively negated by the fact that I'm paying it back with aftertax dollars. Only the interest part that I'm paying on my loan is truly taxed twice.

www.morningstar.com/articles/765399/401k-loans-mythbusters-edition

[The Walk of the Penguin Mich]

Nov 4, 2022 22:32:12 GMT -5 minnesotapaintlady said:

Nov 4, 2022 22:28:02 GMT -5 tallguy said:

Yeah.  Generally for most people and in most situations they are a really bad idea. 

I'm just so retirement account poor from putting 50-60% of my income in for the past 5 years.  It sounded more appealing than pulling Roth contributions.

I have holes literally the size of basketballs in my siding now.  It really needs to be taken care of.

We had the whole house resided with hardiplank right before Covid hit.  We have 2800 sq ft, in an expensive area of the US.  We also had the privacy wall rebuilt as it was rotting.  The total cost was about $50k, including painting.  
When we had it done, it was rotting from the ground up.  While the rot did not extend to the lower levels, you could stick a screwdriver into the siding 2/3 the way up the house.

[minnesotapaintlady]

Nov 5, 2022 13:47:14 GMT -5 The Walk of the Penguin Mich said:

Nov 4, 2022 22:32:12 GMT -5 minnesotapaintlady said:

I'm just so retirement account poor from putting 50-60% of my income in for the past 5 years.  It sounded more appealing than pulling Roth contributions.

I have holes literally the size of basketballs in my siding now.  It really needs to be taken care of.

We had the whole house resided with hardiplank right before Covid hit.  We have 2800 sq ft, in an expensive area of the US.  We also had the privacy wall rebuilt as it was rotting.  The total cost was about $50k, including painting.  
When we had it done, it was rotting from the ground up.  While the rot did not extend to the lower levels, you could stick a screwdriver into the siding 2/3 the way up the house.

That's helpful.  I had no clue what the cost might be. 

I'd rather get something that doesn't need painting if possible. 

[CCL]

You guys are killing me. $30k-$50k, that's a lot of money! I understand why it has to be done, though. I wouldn't leave my house like that, either.

Then I hear youngins complaining about brick. I love my brick! A younger couple bought a house (all brick) in the neighborhood. This is a $400k house and they got the idea they could have it painted a blue-gray color. Their contractor got one side done and the HOA shut them down and made them strip it all off. Why would you buy an all-brick house, then paint it? Just go buy a house with siding if you like painting. I guess they like a lot of maintenance.

[CCL]

Could you increase your home equity line/loan?

[tallguy]

Nov 5, 2022 13:41:34 GMT -5 minnesotapaintlady said:

Myth 3: You'll pay taxes twice.
Morningstar Tax Webinar
Webinar
Down Market Tax Strategies


This assertion has been widely debunked, but I still hear it surface here and there: You've put pretax dollars into your 401(k), but you pay back your 401(k) loan with aftertax dollars; you'll owe taxes on that money again when you pull it out during retirement. Therefore, double taxation!

However, that statement greatly exaggerates the tax costs of taking a 401(k) loan; the only money "taxed twice" in the transaction is the interest paid. Meanwhile, the 401(k) borrower is able to take the loan, consisting of money that has never been taxed, without tax consequences.

Say, for example, I borrow $10,000 from my 401(k) on Tuesday, because my sister needs a loan until she receives a commission check on Friday. I'll pay no taxes on the amount that I borrow, and when she pays me back I'll put the $10,000 right back into the account without any tax consequences. The only aftertax money involved in the transaction--and that I'll also owe taxes on again in retirement--is the paltry amount of interest I owe for the three days I had the loan out.

Of course, from a practical standpoint investors often pay back their 401(k) loans with aftertax dollars, in contrast with my example above. Say, for example, I borrow $25,000 from my 401(k) to buy a car. The money I've borrowed tax-free from my 401(k) is sunk in my car and I can't get it out to pay myself back; to pay back my 401(k) loan, I have to use aftertax dollars. But I took the initial $25,000 out tax-free, so it's a wash from a tax perspective; I got a tax break on the amount I borrowed, but that break is effectively negated by the fact that I'm paying it back with aftertax dollars. Only the interest part that I'm paying on my loan is truly taxed twice.

www.morningstar.com/articles/765399/401k-loans-mythbusters-edition

I am not impressed with that author.  Look at it like this:

Let's say you take out a $20,000 401k loan.  When you made the contribution you got a tax break on that money.  It basically cost you just the $20,000 to put the money in.  You got a tax break which you either invested elsewhere or spent.  Great.  If you do not repay the loan, you pay tax on that money just as you would when you withdraw it after retirement.  $20,000 in, $20,000 out.  Taxed once.  Everything balances out.  Now if you repay the loan, you are doing it with after-tax dollars, whether you are doing it over time or in one lump-sum.  It works in his example only because he is not using the money for himself and is not repaying it with his own money.  If he were using the money for himself and repaying it with his own, his example falls apart.  He even admits that in the bolded portion, but even that part is incomplete.
If you repay it through payroll deduction, as I imagine the vast majority of borrowers do, you do not get the tax break again.  For someone in the 12% bracket it effectively takes $22,400 of income (in addition to withholdings for SS and Medicare again) to get that $20,000 back into the account.  At 24% it costs $24,800 to get back to where you were with that $20,000 back and invested in your account.  Any interest is on top of that.  Even then, you will still be taxed on everything in the account when you withdraw it later.  And even if you repay it in a lump sum with other money outside of your payroll deduction, that money still came from somewhere.  If it was your money that came from your own accounts, it was most likely taxed before when you earned it.  So yes, it is double taxation.  You are taxed on the $22,400 to get the $20,000 back into your account.  You will then be taxed again on the $20,000 when you eventually withdraw it.  Any of your own money that goes to repaying a 401k loan is taxed on the way in and on the way out.  It is also likely true that the largest actual cost of taking a 401k loan is the lost growth from not having the money invested during that time.   

[tallguy]

Nov 5, 2022 13:32:28 GMT -5 NastyWoman said:

Nov 4, 2022 22:57:12 GMT -5 tallguy said:

Find another way, even if it is merely stopping your current contributions.  It depends on the plan, but some plans stipulate that you cannot make additional contributions until the loan is paid off anyway.  Also, you will be repaying the loan with after-tax money.  It is not as simple as having them take the money out pretax as they do for contributions.  Definitely look into all of the issues involved before you consider it further.  And no, I would not recommend taking money out of Roth either.  I consider mine the most important money I have, and time only increases that.  

that sounds a lot like setting yourself up for double taxation as the repaid money will go i to a tax deferred account and is subject to taxation upon withdrawal. Or is there a mechanism to work around this in place?

Not generally that I am aware of.  You may be able to withdraw tax-free up to the level of your standard or itemized deductions depending on other income (if you are even able to keep it in the 401k and not roll it over), but other than that?  I can't think of one offhand.  Once you roll it over to an IRA it also opens up QCDs, but that defeats the objective of taking the money for yourself.

[minnesotapaintlady]

Nov 5, 2022 15:41:38 GMT -5 CCL said:

You guys are killing me. $30k-$50k, that's a lot of money! I understand why it has to be done, though. I wouldn't leave my house like that, either.

Then I hear youngins complaining about brick. I love my brick! A younger couple bought a house (all brick) in the neighborhood. This is a $400k house and they got the idea they could have it painted a blue-gray color. Their contractor got one side done and the HOA shut them down and made them strip it all off. Why would you buy an all-brick house, then paint it? Just go buy a house with siding if you like painting. I guess they like a lot of maintenance.

No lie!  Why do you think I've put it off for so long!   The thought of sticking that kind of money into this place makes me sick...especially since it still floods.  I kept hoping we'd get a bad enough storm that the siding would get damaged and insurance would cover a lot of it, but it was always just the roof.

And I love brick houses!  When I was down south this year I was noticing all the brick ranch houses everywhere and thought they were so "solid" looking. 

[minnesotapaintlady]

Nov 5, 2022 15:44:43 GMT -5 CCL said:

Could you increase your home equity line/loan?

Maybe.  It actually expires in 2025 I think, so not sure what happens then.  Plus the interest rate has been jumping up leaps and bounds on it the past few months.

But, who knows what things will be like next summer.  The stock market may have recovered and interest rates dropped back down...or not. 

I would be ok with taking about 10K from I bonds and if I didn't put any money in bonds or Roth next year I could scrape together another 12K there.  So, that's 22K.  I was hoping to get this taken care of for less than 30K, but I don't know...just my roof was 20K last year.

[tallguy]

Nov 5, 2022 15:41:38 GMT -5 CCL said:

You guys are killing me. $30k-$50k, that's a lot of money! I understand why it has to be done, though. I wouldn't leave my house like that, either.

Then I hear youngins complaining about brick. I love my brick! A younger couple bought a house (all brick) in the neighborhood. This is a $400k house and they got the idea they could have it painted a blue-gray color. Their contractor got one side done and the HOA shut them down and made them strip it all off. Why would you buy an all-brick house, then paint it? Just go buy a house with siding if you like painting. I guess they like a lot of maintenance.

While I much prefer brick to wood or siding, I absolutely prefer stone to brick.  It is much more visually interesting.  With brick, they are all the same size and often the same color with little variation.  Brick also has a flat surface look.  With stone they are not all the same shape or size, and you can have more color variation either within each stone or from stone to stone while still looking very natural.  It is also not a flat surface, which increases the visual appeal for me.   

Either way, I cannot imagine paying $10-20,000 to paint a house or $30-50,000 for siding.  And to do it more than once, as you would likely have to do with paint? Oh no.