How much debt can one reasonably repay per year?

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birdlaw117
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Re: How much debt can one reasonably repay per year?

Postby birdlaw117 » Tue Aug 02, 2011 6:03 pm

albusdumbledore wrote:
ToTransferOrNot wrote:bird:

The "extra amount" would only get compounded an "extra" 40 times if you were never going to make additional payments to the 401k in years 5-10 to make up for what you didn't put in in years 1-4. That's not what I'm suggesting at all.

True. But 401ks have a maximum of 16500 for a yearly contribution. IRA's have a max of 5k. So for what you're saying to hold true, you'd have to be contributing 50% or less of the max contribution every year. At which point you're already screwing yourself out of those returns.

Damnit, I was just about to mention this. Always one step ahead of me...

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albusdumbledore
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Re: How much debt can one reasonably repay per year?

Postby albusdumbledore » Tue Aug 02, 2011 6:04 pm

birdlaw117 wrote:
albusdumbledore wrote:
ToTransferOrNot wrote:bird:

The "extra amount" would only get compounded an "extra" 40 times if you were never going to make additional payments to the 401k in years 5-10 to make up for what you didn't put in in years 1-4. That's not what I'm suggesting at all.

True. But 401ks have a maximum of 16500 for a yearly contribution. IRA's have a max of 5k. So for what you're saying to hold true, you'd have to be contributing 50% or less of the max contribution every year. At which point you're already screwing yourself out of those returns.

Damnit, I was just about to mention this. Always one step ahead of me...

:lol:

ToTransferOrNot
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Re: How much debt can one reasonably repay per year?

Postby ToTransferOrNot » Tue Aug 02, 2011 6:13 pm

birdlaw117 wrote:
albusdumbledore wrote:
ToTransferOrNot wrote:bird:

The "extra amount" would only get compounded an "extra" 40 times if you were never going to make additional payments to the 401k in years 5-10 to make up for what you didn't put in in years 1-4. That's not what I'm suggesting at all.

True. But 401ks have a maximum of 16500 for a yearly contribution. IRA's have a max of 5k. So for what you're saying to hold true, you'd have to be contributing 50% or less of the max contribution every year. At which point you're already screwing yourself out of those returns.

Damnit, I was just about to mention this. Always one step ahead of me...


I guess the question is whether the returns in non-401k investments in years 5-10 that you otherwise could not have made (if you were investing in years 1-4) would outperform the additional gains from compounding that you get in years 1-4.

I admittedly don't know how to do the math on that. Annoying.

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rayiner
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Re: How much debt can one reasonably repay per year?

Postby rayiner » Tue Aug 02, 2011 6:16 pm

ToTransferOrNot wrote:
IAFG wrote:With so many unknown variables, I think you should do whatever helps you sleep at night. If that is "buying your freedom" by paying off your loans, do that. If it's keeping cash available/in low risk investments, do that. The unknowns eat up the margin btw the two, so neither answer is obviously right or wrong. Except blowing it all on models and bottles.


Obviously the right answer.

Edit: Also, seriously, if you have any insight into the "buying a house" thing that you think I'm missing, please let me know. I'm not trying to be snipeish on that - it really is a question I've agonized over, since I have to make up my mind pretty soon.


My thoughts on buying a house (cognizant of the fact that it'd be in either NYC or DC):

1) Interest rates are at historic lows right now. I don't see anything that would make them skyrocket soon, although I do think we're not that far away from a period of relatively substantial inflation that is going to cause interest rates to rise.

2) In the stronger metro markets we may actually not have hit the housing price trough yet. While the real bubble areas crashed hard and are now even creeping back up, the stronger areas are still declining as the economy continues to be sour.

If interest rates are still low in a couple of years, I think it'd be a great time to buy. I personally intend to bank everything I can during my first couple and change, then see where interest rates are at. Between the tax benefits of your stub year and leaving cheaply it should not be hard to put away $40k or so which would be enough to buy a house at a decent interest rate.

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rayiner
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Re: How much debt can one reasonably repay per year?

Postby rayiner » Tue Aug 02, 2011 6:17 pm

ToTransferOrNot wrote:
birdlaw117 wrote:
albusdumbledore wrote:
ToTransferOrNot wrote:bird:

The "extra amount" would only get compounded an "extra" 40 times if you were never going to make additional payments to the 401k in years 5-10 to make up for what you didn't put in in years 1-4. That's not what I'm suggesting at all.

True. But 401ks have a maximum of 16500 for a yearly contribution. IRA's have a max of 5k. So for what you're saying to hold true, you'd have to be contributing 50% or less of the max contribution every year. At which point you're already screwing yourself out of those returns.

Damnit, I was just about to mention this. Always one step ahead of me...


I guess the question is whether the returns in non-401k investments in years 5-10 that you otherwise could not have made (if you were investing in years 1-4) would outperform the additional gains from compounding that you get in years 1-4.

I admittedly don't know how to do the math on that. Annoying.


Obviously depends on your tax rate in retirement.

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birdlaw117
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Re: How much debt can one reasonably repay per year?

Postby birdlaw117 » Tue Aug 02, 2011 6:21 pm

rayiner wrote:Obviously depends on your tax rate in retirement.

True. But time value of money would probably negate any higher tax liability, though not necessarily.

Also, being able to continue to earn on that future tax liability is a huge benefit.

ClarDarr
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Re: How much debt can one reasonably repay per year?

Postby ClarDarr » Tue Aug 02, 2011 6:35 pm

this thread has certainly taken a different direction than I imagined, but its also things I should be thinking about. So that's definitely good.

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DaveBear07
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Re: How much debt can one reasonably repay per year?

Postby DaveBear07 » Tue Aug 02, 2011 8:23 pm

birdlaw117 wrote:
albusdumbledore wrote:
DaveBear07 wrote:I'm open to other plans because money is money--- but everything I've read and heard points towards:

1) Budget (rent, utilities, food, insurance, emergency, 6-8 months of income, etc.)
2) Debt at approx. 8% interest.
3) Down Payment on House and Matching 401k.
4) Investing for currently-decades-away-matters such as kids' college and retirement.

Thoughts?

I have an issue with #3 too. I constantly see people on here rationalize paying off their debts before doing something like maxing out their 401k contribution because "there's no way you're gonna beat the guaranteed 7% interest rate on the loans". Well, sure, for a single year. The issue is that if you wait to contribute to your 401k and instead you hammer those loans a little bit faster, the amount you're giving up isn't a single 7% return. The amount you're giving up is the amount you would have paid in for that year, compounded at 7%(or whatever return you end up making in the markets) for every year until you retire. Which is a whole hell of a lot more than a 7% return.

This. Sure, both interest rates compound, but the 401k will keep compounding after you've paid off the debt, and at that point the compounding interest will earn a bunch. Plus, loans will be compounding on gradually decreasing amounts while retirement accounts will compound on gradually increasing amounts.

ETA: Albus, you beat me to it.


Got it. Match 401k and pay down debt.

LawWeb
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Re: How much debt can one reasonably repay per year?

Postby LawWeb » Wed Aug 03, 2011 1:39 am

An additional note about 410k's - there's a great deal some may not be aware of - taking a loan from your 401k. It may sound bad, but it can be about the best move you can make. You can withdraw up to 1/2 of your 401k as a "loan" to yourself. It gets paid back through auto-deductions from your paycheck. You pay an interest rate of only about 4.5 % - and, best part, you pay that interest to yourself (it just becomes part of your principle). So, if you give to your 401k instead of doing other things, you will be up pre-tax principle (and extra 30% or so to work with), get some match from the company, and then be able to use that money to pay down a chunk of your loans, not only lowering the interest rate, but really eliminating any interest/increasing your 410k savings.

And if for someone reason you got laid off and had to "default," it's not really a default - you just end up having to pay the 10% early withdrawal and taxes on the balance - no blow to your credit rating.

HamDel
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Re: How much debt can one reasonably repay per year?

Postby HamDel » Wed Aug 03, 2011 2:02 am

rayiner wrote:
XxSpyKEx wrote:
rayiner wrote:
ToTransferOrNot wrote:Re: Not putting everything into loans to get the 7.6% return vs. (i) investing in other things or (ii) putting money into 401k:

(i) I cannot fathom any investment that has a high enough IRR to justify not taking the 100%-certain 7.6% (and this number should be higher - the smart money puts all of their loans into 25-year repayment but still pays the same amount overall. This allows you to put more money into the highest-rate loans. Consolidating makes absolutely no sense when you have some loans at 6.8 and some at 7.9/8.5 (depending on when you took your GradPLUS loans out)). Sure, you might be able to get 10% elsewhere - or you might get stung. 7.6% is a really, really high risk-free rate; getting another 2% doesn't justify the additional risk you take on.

Additionally, the 7.6% isn't subject to another level of tax (presumably capital gains, because getting higher than 7.6% on interest probably isn't going to happen) - which makes the 7.6% even more attractive.

(ii) I'm not going to contribute to my 401k. If your firm has a match, then you obviously contribute up to the match - that's a no-brainer. But if the firm doesn't have a match, I am not confident enough that any 401k gains are going to outdo the certain return on paying loans - not to mention the flexibility that comes with paying down loans faster (unlike other investments, you can't raid the 401k to pay off your loans early, if you have a change of heart). More importantly, I would say that the chances of taxes being much higher when we're old enough to draw on 401ks makes the tax deferral aspect be of questionable value. Again, you're considering an uncertain return later vs a very certain return now.


There is a big liquidity advantage to having $75k in the bank versus having paid it off in loans.


A reasonable person doesn't leave $75k sitting in a bank (unless you're filthy rich and need that much money at a moment's notice because you're blowing something like $75k /month). Short-term investments, on the other hand, are risky, especially when you're talking about 2-3 year investments, like we are here (i.e. the cost of 2-3 year of interest in repaying student loans vs. the potential gain of investing the money for those 2-3 years). Personally, I would rather be debt-free than take risks with hopes of making an extra 2% interest (relative to gains if the money went towards repaying the loans) on that $75k. It'd be a different story if the economy was booming right now, and people were seeing something like 20% returns on large cap stocks.

Just to be clear, I'm not saying it's reasonable to not save anything. But $75k is a lot of money to just sit on when the economy is shitty like it is right now (especially if you live somewhere cheap like Texas), where you can't very easily make returns exceeding your student loan interest rates.


It's not about making a return on that money. It's about having short-term assets that you can liquidate relatively quickly just in case. What if you're presented with an unexpected opportunity? It could be a business opportunity or even just finding a great deal on a house.

Say you owe $200k. Your payments are $2,400 per month. You put an extra $1,100 per month into your loans, for a total of $3,500. Now, say your take-home is roughly $8,500 (you live in NJ). Allowing for $2,500 rent and $1,000 other expenses, you've got $1,500 left over each month. What to do with it?

If you don't put it towards loans, your total loan interest over the life of the loan will be $50,000. If you do put it towards your loans, you'll save $20,00 in interest. But, in the first scenario, even with a weak rate of return of 5%, you'll have earned $17,500 in interest, $15,000 after capital gains. So you're only down $5,000. What is the value to you of being able to take advantage of an opportunity by having a relatively large liquid savings?


This post brought the Simpsons episode where the town buys the monorail to mind. WHAT IF THERE'S A BIG AMAZING INVESTMENT OPPORTUNITY??? THE MONORAIL WILL MAKE YA RICH I TELLS YA!!

I want to get rid of my debt ASAP and will live in a shitty apartment and buy nothing for two years to handle a huge chunk of it. You don't know when the biglaw train is going to boot you off, and you don't want to be stuck with a pile of loans when that happens.

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rayiner
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Re: How much debt can one reasonably repay per year?

Postby rayiner » Wed Aug 03, 2011 2:09 am

HamDel wrote:
rayiner wrote:
XxSpyKEx wrote:
rayiner wrote:
There is a big liquidity advantage to having $75k in the bank versus having paid it off in loans.


A reasonable person doesn't leave $75k sitting in a bank (unless you're filthy rich and need that much money at a moment's notice because you're blowing something like $75k /month). Short-term investments, on the other hand, are risky, especially when you're talking about 2-3 year investments, like we are here (i.e. the cost of 2-3 year of interest in repaying student loans vs. the potential gain of investing the money for those 2-3 years). Personally, I would rather be debt-free than take risks with hopes of making an extra 2% interest (relative to gains if the money went towards repaying the loans) on that $75k. It'd be a different story if the economy was booming right now, and people were seeing something like 20% returns on large cap stocks.

Just to be clear, I'm not saying it's reasonable to not save anything. But $75k is a lot of money to just sit on when the economy is shitty like it is right now (especially if you live somewhere cheap like Texas), where you can't very easily make returns exceeding your student loan interest rates.


It's not about making a return on that money. It's about having short-term assets that you can liquidate relatively quickly just in case. What if you're presented with an unexpected opportunity? It could be a business opportunity or even just finding a great deal on a house.

Say you owe $200k. Your payments are $2,400 per month. You put an extra $1,100 per month into your loans, for a total of $3,500. Now, say your take-home is roughly $8,500 (you live in NJ). Allowing for $2,500 rent and $1,000 other expenses, you've got $1,500 left over each month. What to do with it?

If you don't put it towards loans, your total loan interest over the life of the loan will be $50,000. If you do put it towards your loans, you'll save $20,00 in interest. But, in the first scenario, even with a weak rate of return of 5%, you'll have earned $17,500 in interest, $15,000 after capital gains. So you're only down $5,000. What is the value to you of being able to take advantage of an opportunity by having a relatively large liquid savings?


This post brought the Simpsons episode where the town buys the monorail to mind. WHAT IF THERE'S A BIG AMAZING INVESTMENT OPPORTUNITY??? THE MONORAIL WILL MAKE YA RICH I TELLS YA!!

I want to get rid of my debt ASAP and will live in a shitty apartment and buy nothing for two years to handle a huge chunk of it. You don't know when the biglaw train is going to boot you off, and you don't want to be stuck with a pile of loans when that happens.


The "when the biglaw train is going to boot you off" issue is a total red herring to justify "get rid of my debt ASAP." It's a reason to not spend your money and instead save it, but if you get Lathamed after two years you're absolutely better off having that money in the bank than having paid it down.

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vanwinkle
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Re: How much debt can one reasonably repay per year?

Postby vanwinkle » Wed Aug 03, 2011 9:30 am

HamDel wrote:I want to get rid of my debt ASAP and will live in a shitty apartment and buy nothing for two years to handle a huge chunk of it. You don't know when the biglaw train is going to boot you off, and you don't want to be stuck with a pile of loans when that happens.

Nobody's telling you to spend or dispose of the money you would be putting toward debt reduction. They're encouraging you to save it. If you have that money in the bank, then you're stuck with a pile of loans and the money you were going to use to pay them off. Then you have flexibility, and you can choose: Do I put it all toward loans, or do I use some to buy food and pay rent?

If you pay off your loans and then get "the boot", you're stuck with no income and no savings. In that situation you don't have a choice. You can't re-take those loans and use the money to buy rent and food. That money's gone, and you're just flat broke until you find your next job, whenever that is.

Not only that, but if your next job pays substantially less, the gov't will start paying a chunk of those loans for you. In that case, it was doubly foolish to pay them all off right away. You had no savings to survive your period of unemployment, and you took all the money from your sole high-income period and blew it all paying off something that someone else would've ended up paying off for you.

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albusdumbledore
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Re: How much debt can one reasonably repay per year?

Postby albusdumbledore » Wed Aug 03, 2011 9:41 am

LawWeb wrote:An additional note about 410k's - there's a great deal some may not be aware of - taking a loan from your 401k. It may sound bad, but it can be about the best move you can make. You can withdraw up to 1/2 of your 401k as a "loan" to yourself. It gets paid back through auto-deductions from your paycheck. You pay an interest rate of only about 4.5 % - and, best part, you pay that interest to yourself (it just becomes part of your principle). So, if you give to your 401k instead of doing other things, you will be up pre-tax principle (and extra 30% or so to work with), get some match from the company, and then be able to use that money to pay down a chunk of your loans, not only lowering the interest rate, but really eliminating any interest/increasing your 410k savings.

And if for someone reason you got laid off and had to "default," it's not really a default - you just end up having to pay the 10% early withdrawal and taxes on the balance - no blow to your credit rating.

Wow, did not know this, but this is good advice.

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vanwinkle
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Re: How much debt can one reasonably repay per year?

Postby vanwinkle » Wed Aug 03, 2011 10:37 am

LawWeb wrote:An additional note about 410k's - there's a great deal some may not be aware of - taking a loan from your 401k. It may sound bad, but it can be about the best move you can make. You can withdraw up to 1/2 of your 401k as a "loan" to yourself. It gets paid back through auto-deductions from your paycheck. You pay an interest rate of only about 4.5 % - and, best part, you pay that interest to yourself (it just becomes part of your principle). So, if you give to your 401k instead of doing other things, you will be up pre-tax principle (and extra 30% or so to work with), get some match from the company, and then be able to use that money to pay down a chunk of your loans, not only lowering the interest rate, but really eliminating any interest/increasing your 410k savings.

This is not an option if you're laid off, or even if you're changing jobs. You're not permitted to have a 401(k) loan after you leave your employer. If you have an outstanding 401(k) loan and you lose your job, it matter whether you get fired, quit, or get laid off, you have 60 days beyond your termination date to repay the loan balance, and that's it. This is true even if you're quitting to start another job somewhere else. Anything that hasn't been paid back within 60 days is treated as a taxable withdrawal and is subject to the 10% withdrawal penalty.

A 401(k) loan isn't a real option for surviving a period of unemployment. You're only going to be able to make a withdrawal under those circumstances, taxes, penalty fees and all.

ClarDarr
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Re: How much debt can one reasonably repay per year?

Postby ClarDarr » Wed Aug 03, 2011 10:44 am

vanwinkle wrote:
LawWeb wrote:An additional note about 410k's - there's a great deal some may not be aware of - taking a loan from your 401k. It may sound bad, but it can be about the best move you can make. You can withdraw up to 1/2 of your 401k as a "loan" to yourself. It gets paid back through auto-deductions from your paycheck. You pay an interest rate of only about 4.5 % - and, best part, you pay that interest to yourself (it just becomes part of your principle). So, if you give to your 401k instead of doing other things, you will be up pre-tax principle (and extra 30% or so to work with), get some match from the company, and then be able to use that money to pay down a chunk of your loans, not only lowering the interest rate, but really eliminating any interest/increasing your 410k savings.

This is not an option if you're laid off, or even if you're changing jobs. You're not permitted to have a 401(k) loan after you leave your employer. If you have an outstanding 401(k) loan and you lose your job, it matter whether you get fired, quit, or get laid off, you have 60 days beyond your termination date to repay the loan balance, and that's it. This is true even if you're quitting to start another job somewhere else. Anything that hasn't been paid back within 60 days is treated as a taxable withdrawal and is subject to the 10% withdrawal penalty.

A 401(k) loan isn't a real option for surviving a period of unemployment. You're only going to be able to make a withdrawal under those circumstances, taxes, penalty fees and all.


Certainly not a good survival method post employment, but definitely a good way to pay off principle on loans while employed.

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albusdumbledore
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Re: How much debt can one reasonably repay per year?

Postby albusdumbledore » Wed Aug 03, 2011 10:46 am

ClarDarr wrote:Certainly not a good survival method post employment, but definitely a good way to pay off principle on loans while employed.

After some googling, I see that many plans don't let you contribute to your 401k while you have a loan out against it. That's also a significant disadvantage.

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vanwinkle
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Re: How much debt can one reasonably repay per year?

Postby vanwinkle » Wed Aug 03, 2011 10:50 am

albusdumbledore wrote:
ClarDarr wrote:Certainly not a good survival method post employment, but definitely a good way to pay off principle on loans while employed.

After some googling, I see that many plans don't let you contribute to your 401k while you have a loan out against it. That's also a significant disadvantage.

This is a good point also. The 401(k) plan at my old employer had that rule. You're denying yourself the ability to contribute and reap the tax savings by taking out loans. Just one of a bunch of reasons that 401(k) loans aren't that convenient.

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Nom Sawyer
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Re: How much debt can one reasonably repay per year?

Postby Nom Sawyer » Wed Aug 03, 2011 11:15 am

Man reading law student discussions on Finance and Compound interest is always great fun hahaha...

Anyways I think the best approach is yes, paying down your loans is the best investment opportunity you will have your first several years out (other than the very, very specific & limited circumstances where you would even consider buying a house that Rayiner is talking about) BUT you want to keep a decent amount of liquid cash on hand in case something happens. The whole discussion on 401K stuff is a non starter... the difference in tax brackets will not be significant when you have something like a guaranteed 8% return.

To summarize: Don't keep 75k cash... you don't need that much and you'll have the greatest return paying down your loans (even given 401K caps and all that). But don't sock every single extra dollar you have into your loans... make sure you keep a decent amount in liquid assets in case something happens.

LawWeb
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Re: How much debt can one reasonably repay per year?

Postby LawWeb » Thu Aug 04, 2011 1:24 am

vanwinkle wrote:
albusdumbledore wrote:
ClarDarr wrote:Certainly not a good survival method post employment, but definitely a good way to pay off principle on loans while employed.

After some googling, I see that many plans don't let you contribute to your 401k while you have a loan out against it. That's also a significant disadvantage.

This is a good point also. The 401(k) plan at my old employer had that rule. You're denying yourself the ability to contribute and reap the tax savings by taking out loans. Just one of a bunch of reasons that 401(k) loans aren't that convenient.

To answer a couple points above: 1) if you are laid off/switch jobs, you have the option just to continue paying the monthly payments until you have your next job (and after), to pay it back, or take it as a disbursement. In my case, I still had some outstanding when I left my job for law school. I just kept making the payments until it was paid back. So if you switch jobs, not an issue, just keep with the payments - if you are laid of for a short while, not an issue. Worst case (long-term layoff) is a 10% penalty rather than having no way to pay your loans. All things to consider, but it can work out well, as it did for me. 2) You can still contribute while you have your loan outstanding, at least the plans I've had. No restriction at all.

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vanwinkle
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Re: How much debt can one reasonably repay per year?

Postby vanwinkle » Thu Aug 04, 2011 10:31 am

LawWeb wrote:To answer a couple points above: 1) if you are laid off/switch jobs, you have the option just to continue paying the monthly payments until you have your next job (and after), to pay it back, or take it as a disbursement.

Is this referring to 401(k) loans? Because if so, it's simply not true. Your options are to 1) pay it back in full within 60 days or 2) get it treated as a disbursement. If you partially repay it within 60 days, the remaining balance will be treated as a disbursement. But there's no "continue paying the monthly payments" option. You have 60 days and that's it.

I'm saying this as someone who had a 401(k) and looked into such loans. They don't care if you have a next job or not. You leave the employer you have the 401(k) with, you have 60 days, period.

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Tiago Splitter
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Re: How much debt can one reasonably repay per year?

Postby Tiago Splitter » Thu Aug 04, 2011 12:13 pm

vanwinkle wrote:
LawWeb wrote:To answer a couple points above: 1) if you are laid off/switch jobs, you have the option just to continue paying the monthly payments until you have your next job (and after), to pay it back, or take it as a disbursement.

Is this referring to 401(k) loans? Because if so, it's simply not true. Your options are to 1) pay it back in full within 60 days or 2) get it treated as a disbursement. If you partially repay it within 60 days, the remaining balance will be treated as a disbursement. But there's no "continue paying the monthly payments" option. You have 60 days and that's it.

I'm saying this as someone who had a 401(k) and looked into such loans. They don't care if you have a next job or not. You leave the employer you have the 401(k) with, you have 60 days, period.


Also incorrect. While the irs lays out the ground rules for 401k loans, the plan determines what to do when a participant separates from service with an outstanding loan. The plan is also not required to disallow contributions after a loan is taken.




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