Math is hard. 401(k) loan to pay down debt?

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thesealocust
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Math is hard. 401(k) loan to pay down debt?

Postby thesealocust » Tue Mar 26, 2013 1:36 am

But an idea just struck me - would it be potentially advantageous to contribute money to a 401(k) plan, then take a loan against your 401(k) and use that money to pay down student debt?

It could theoretically allow you to shovel pre-tax dollars into your student loans, couldn't it?

This is a very complex question, and I'm about to go to bed so I can't run through all the math / tax implications / laws, but has anybody out there already thought about this?

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UnfrozenCaveman
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Re: Math is hard. 401(k) loan to pay down debt?

Postby UnfrozenCaveman » Tue Mar 26, 2013 9:29 am

Could work but I'm pretty sure the tax penalties would be too high.

exitoptions
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Re: Math is hard. 401(k) loan to pay down debt?

Postby exitoptions » Tue Mar 26, 2013 9:34 am

My understanding is there is no penalty if you repay the loan w/ interest (to yourself) within 5 years. The max you can borrow right now is $50k or half the amount in your acount (whichever is lower). This is definitely an option, although the 5 year period makes it less attractive because you'll potentially have to pay it back faster than your student loans, which some may not be able to do on the crap salaries lawyers are getting these days.

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nealric
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Re: Math is hard. 401(k) loan to pay down debt?

Postby nealric » Tue Mar 26, 2013 11:26 am

One hitch is that the loan is usually accelerated if you leave your employer. If you don't have cash on hand, that could cause a big early withdrawal penalty (likely destroying the remaining 50%).

Big Dog
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Re: Math is hard. 401(k) loan to pay down debt?

Postby Big Dog » Tue Mar 26, 2013 11:45 am

It could theoretically allow you to shovel pre-tax dollars into your student loans


While borrowing against a 401(k) has some merit (you are literally paying interest to yourself), you do not get to pay it back with pre-tax dollars. When you borrow against your 40k(k), your employer will withhold the repayment, but it will be after-tax (by law).

And yes, it is hugely risky, since as the earlier poster mentioned, if you leave -- for whatever reason -- that employer, the full loan is due and payable. If you do not have the cash to pay the loan back, you will be subject to early withdrawal penalties.

mirodh
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Re: Math is hard. 401(k) loan to pay down debt?

Postby mirodh » Tue Mar 26, 2013 11:55 am

This is very interesting... But you would also only be able to use half the amount you put in... If you have substantial loans at 8% is the delay in paying them worth it?

pianogirl
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Re: Math is hard. 401(k) loan to pay down debt?

Postby pianogirl » Tue Mar 26, 2013 12:04 pm

Wouldn't this qualify as a hardship withdrawal with no penalty?

kryptix
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Re: Math is hard. 401(k) loan to pay down debt?

Postby kryptix » Tue Mar 26, 2013 12:59 pm

mirodh wrote:This is very interesting... But you would also only be able to use half the amount you put in... If you have substantial loans at 8% is the delay in paying them worth it?


I guess its worth it if you are going to max your 401k contribution then use half of it to pay your loans, and then immediately repay the 401k as well so your contributions for the next year could once again be taken out to use on your loans. It doesn't seem like it would be a very good deal unless you already had a substantial 401k going in though. For example if you already had a 100k 401k from a previous career, you could take out 50k right away in your first year in big law and pay off 50k of your loans, then repay that 50k over the course of your first year in big law. Do it again your second year, etc. This would definitely save you money vs paying 50k after tax.

However, if you didn't have the 100k 401k already, contributing 17.5k a year you would be able to take out 8.75k the first year, 17.5k the second year and so on (not counting growth). This wouldn't help nearly as much because your still making the majority of your payments with after tax money in the first few years. Its probably not worth dragging your loans out for 2-3 more years for your 401k to catch up.


However, I believe a withdrawal will still be subject to the 10% penalty even if it is for hardship unless its for medical bills, so you'd have to factor that in.

If you take it out as a loan, you don't pay the penalty, but you have to repay the loan with after tax money, and you get taxed again when you collect it as a distribution when you retire. That's an additional consideration because your 50k pre tax that you take out to pay student loans is repaid with interest to the plan, increasing your principle. However that 50k+interest you paid back with after tax money will be taxed again when you withdraw the money after your 59 1/2. Presumably you'll be in a lower tax bracket then, but your still paying taxes on money that was already taxed. Whether it works out for you in the end depends on the difference between your tax bracket now and when you retire, and also on the growth of the extra principle you have in your 401k (that is not counted towards the contribution limits).

mirodh
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Re: Math is hard. 401(k) loan to pay down debt?

Postby mirodh » Tue Mar 26, 2013 1:08 pm

kryptix wrote:
mirodh wrote:This is very interesting... But you would also only be able to use half the amount you put in... If you have substantial loans at 8% is the delay in paying them worth it?


I guess its worth it if you are going to max your 401k contribution then use half of it to pay your loans, and then immediately repay the 401k as well so your contributions for the next year could once again be taken out to use on your loans. It doesn't seem like it would be a very good deal unless you already had a substantial 401k going in though. For example if you already had a 100k 401k from a previous career, you could take out 50k right away in your first year in big law and pay off 50k of your loans, then repay that 50k over the course of your first year in big law. Do it again your second year, etc. This would definitely save you money vs paying 50k after tax.

However, if you didn't have the 100k 401k already, contributing 17.5k a year you would be able to take out 8.75k the first year, 17.5k the second year and so on (not counting growth). This wouldn't help nearly as much because your still making the majority of your payments with after tax money in the first few years. Its probably not worth dragging your loans out for 2-3 more years for your 401k to catch up.


However, I believe a withdrawal will still be subject to the 10% penalty even if it is for hardship unless its for medical bills, so you'd have to factor that in.

If you take it out as a loan, you don't pay the penalty, but you have to repay the loan with after tax money, and you get taxed again when you collect it as a distribution when you retire. That's an additional consideration because your 50k pre tax that you take out to pay student loans is repaid with interest to the plan, increasing your principle. However that 50k+interest you paid back with after tax money will be taxed again when you withdraw the money after your 59 1/2. Presumably you'll be in a lower tax bracket then, but your still paying taxes on money that was already taxed. Whether it works out for you in the end depends on the difference between your tax bracket now and when you retire, and also on the growth of the extra principle you have in your 401k (that is not counted towards the contribution limits).


I thought it was only the interest which is taxed--I didn't think there was double taxation at all.

kryptix
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Re: Math is hard. 401(k) loan to pay down debt?

Postby kryptix » Tue Mar 26, 2013 1:14 pm

mirodh wrote:
kryptix wrote:
mirodh wrote:This is very interesting... But you would also only be able to use half the amount you put in... If you have substantial loans at 8% is the delay in paying them worth it?


I guess its worth it if you are going to max your 401k contribution then use half of it to pay your loans, and then immediately repay the 401k as well so your contributions for the next year could once again be taken out to use on your loans. It doesn't seem like it would be a very good deal unless you already had a substantial 401k going in though. For example if you already had a 100k 401k from a previous career, you could take out 50k right away in your first year in big law and pay off 50k of your loans, then repay that 50k over the course of your first year in big law. Do it again your second year, etc. This would definitely save you money vs paying 50k after tax.

However, if you didn't have the 100k 401k already, contributing 17.5k a year you would be able to take out 8.75k the first year, 17.5k the second year and so on (not counting growth). This wouldn't help nearly as much because your still making the majority of your payments with after tax money in the first few years. Its probably not worth dragging your loans out for 2-3 more years for your 401k to catch up.


However, I believe a withdrawal will still be subject to the 10% penalty even if it is for hardship unless its for medical bills, so you'd have to factor that in.

If you take it out as a loan, you don't pay the penalty, but you have to repay the loan with after tax money, and you get taxed again when you collect it as a distribution when you retire. That's an additional consideration because your 50k pre tax that you take out to pay student loans is repaid with interest to the plan, increasing your principle. However that 50k+interest you paid back with after tax money will be taxed again when you withdraw the money after your 59 1/2. Presumably you'll be in a lower tax bracket then, but your still paying taxes on money that was already taxed. Whether it works out for you in the end depends on the difference between your tax bracket now and when you retire, and also on the growth of the extra principle you have in your 401k (that is not counted towards the contribution limits).


I thought it was only the interest which is taxed--I didn't think there was double taxation at all.


I'm pretty sure if you take out a loan from the pretax portion of the 401k, repayment is counted still as part of the "pre-tax" part of the 401k so it will get retaxed when you collect your distribution.

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quakeroats
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Re: Math is hard. 401(k) loan to pay down debt?

Postby quakeroats » Tue Mar 26, 2013 1:14 pm

nealric wrote:One hitch is that the loan is usually accelerated if you leave your employer. If you don't have cash on hand, that could cause a big early withdrawal penalty (likely destroying the remaining 50%).


This is the main hitch, but assuming your loan is accelerated and you default in a future year, the outstanding loan amount will be added to your income in the year you default (from what I remember). You'll owe income taxes on that amount plus 10%, but it'll be at your new marginal rate. This isn't necessarily that much of a risk if you're moving from a high tax jurisdiction to a low one, particularly if you're making less money in the the year you default.

Mess around with this a bit to get an idea of what the tax results would look like: --LinkRemoved--

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quakeroats
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Re: Math is hard. 401(k) loan to pay down debt?

Postby quakeroats » Tue Mar 26, 2013 1:17 pm

kryptix wrote:
mirodh wrote:
kryptix wrote:
mirodh wrote:This is very interesting... But you would also only be able to use half the amount you put in... If you have substantial loans at 8% is the delay in paying them worth it?


I guess its worth it if you are going to max your 401k contribution then use half of it to pay your loans, and then immediately repay the 401k as well so your contributions for the next year could once again be taken out to use on your loans. It doesn't seem like it would be a very good deal unless you already had a substantial 401k going in though. For example if you already had a 100k 401k from a previous career, you could take out 50k right away in your first year in big law and pay off 50k of your loans, then repay that 50k over the course of your first year in big law. Do it again your second year, etc. This would definitely save you money vs paying 50k after tax.

However, if you didn't have the 100k 401k already, contributing 17.5k a year you would be able to take out 8.75k the first year, 17.5k the second year and so on (not counting growth). This wouldn't help nearly as much because your still making the majority of your payments with after tax money in the first few years. Its probably not worth dragging your loans out for 2-3 more years for your 401k to catch up.


However, I believe a withdrawal will still be subject to the 10% penalty even if it is for hardship unless its for medical bills, so you'd have to factor that in.

If you take it out as a loan, you don't pay the penalty, but you have to repay the loan with after tax money, and you get taxed again when you collect it as a distribution when you retire. That's an additional consideration because your 50k pre tax that you take out to pay student loans is repaid with interest to the plan, increasing your principle. However that 50k+interest you paid back with after tax money will be taxed again when you withdraw the money after your 59 1/2. Presumably you'll be in a lower tax bracket then, but your still paying taxes on money that was already taxed. Whether it works out for you in the end depends on the difference between your tax bracket now and when you retire, and also on the growth of the extra principle you have in your 401k (that is not counted towards the contribution limits).


I thought it was only the interest which is taxed--I didn't think there was double taxation at all.


I'm pretty sure if you take out a loan from the pretax portion of the 401k, repayment is counted still as part of the "pre-tax" part of the 401k so it will get retaxed when you collect your distribution.


Yep.

--LinkRemoved--)-Resource-Guide---Plan-Sponsors---General-Distribution-Rules (you're going to have to type this link in manually)

http://www.irs.gov/pub/irs-pdf/p575.pdf

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quakeroats
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Re: Math is hard. 401(k) loan to pay down debt?

Postby quakeroats » Tue Mar 26, 2013 1:22 pm

One other hitch is that 401(k)s are subject to lots of employer-specified rules. One of many things they get to decide is whether you can take a loan at all.

kryptix
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Re: Math is hard. 401(k) loan to pay down debt?

Postby kryptix » Tue Mar 26, 2013 1:24 pm

quakeroats wrote:One other hitch is that 401(k)s are subject to lots of employer-specified rules. One of many things they get to decide is whether you can take a loan at all.


Sounds like something you can negotiate with HR when you get hired :)

mirodh
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Re: Math is hard. 401(k) loan to pay down debt?

Postby mirodh » Tue Mar 26, 2013 1:26 pm

Okay. So I put 1k in my 401k and it is pre-tax dollars. I later take out 1k loan (and am not charged any fees/taxes besides interest). I repay the 1k loan, plus $50 in interest. This 1,050 is all put in on a post-tax basis. When I retire and take this out, the whole 1,050 is now taxed.

I haven't really gotten "double-taxed" on the 1k, since I got the loan amount out and spent it. I have effectively only gotten double taxed on the $50.

Am I wrong here? Putting numbers to things help me understand.

Big Dog
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Re: Math is hard. 401(k) loan to pay down debt?

Postby Big Dog » Tue Mar 26, 2013 1:27 pm

^^ Absolutely no way to negotiate. These are federally-qualified plans and, as such, the rules are clearly spelled out for everyone.

kryptix
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Re: Math is hard. 401(k) loan to pay down debt?

Postby kryptix » Tue Mar 26, 2013 1:30 pm

mirodh wrote:Okay. So I put 1k in my 401k and it is pre-tax dollars. I later take out 1k loan (and am not charged any fees/taxes besides interest). I repay the 1k loan, plus $50 in interest. This 1,050 is all put in on a post-tax basis. When I retire and take this out, the whole 1,050 is now taxed.

I haven't really gotten "double-taxed" on the 1k, since I got the loan amount out and spent it. I have effectively only gotten double taxed on the $50.

Am I wrong here? Putting numbers to things help me understand.


True, but your also not tax advantaged in any way on that money either. IE it doesn't help for sealocust's purposes.

mirodh
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Re: Math is hard. 401(k) loan to pay down debt?

Postby mirodh » Tue Mar 26, 2013 2:25 pm

kryptix wrote:
mirodh wrote:Okay. So I put 1k in my 401k and it is pre-tax dollars. I later take out 1k loan (and am not charged any fees/taxes besides interest). I repay the 1k loan, plus $50 in interest. This 1,050 is all put in on a post-tax basis. When I retire and take this out, the whole 1,050 is now taxed.

I haven't really gotten "double-taxed" on the 1k, since I got the loan amount out and spent it. I have effectively only gotten double taxed on the $50.

Am I wrong here? Putting numbers to things help me understand.


True, but your also not tax advantaged in any way on that money either. IE it doesn't help for sealocust's purposes.

Sure you are...look at the following two scenarios using the same numbers above:

(1) loan from 401k. 1k deposited with tax benefit-->1k loan taken out with no fees-->1050 paid back in (only the 50 is again taxable) == End result of 1050 in 401k, 1k being tax bene'd and 50 being double taxed and 1k less in loans. [basically, you only "lose" the double taxation on the interest and you "gain" the tax treatment of the initial 1k deposit]

(2) Payoff yourself. 1080 paid to loans (1k principal, 80 in interest since you had to wait and pay it) == 1k less loans [basically, you "lose" the interest "gain" nada]

The above was an absolutely horrible example--but you still get the tax treatment of the initial deposit. The subsequent 401k loan and repayment simply cancels out leaving the initial 1k, tax bene'd deposit. You only lose out on the tax treatment of interest (instead of paying the interest itself).

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TTRansfer
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Re: Math is hard. 401(k) loan to pay down debt?

Postby TTRansfer » Tue Mar 26, 2013 2:38 pm

Very interesting.

I still wish I had the ability to "refund" my student loan provider the loan money with my SA payments. Stupid 120 day refund period. :evil:

Jimbo_Jones
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Re: Math is hard. 401(k) loan to pay down debt?

Postby Jimbo_Jones » Tue Mar 26, 2013 2:47 pm

I wonder if having a Roth 401(k) makes any difference regarding tax.

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Tiago Splitter
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Re: Math is hard. 401(k) loan to pay down debt?

Postby Tiago Splitter » Tue Mar 26, 2013 8:20 pm

Jimbo_Jones wrote:I wonder if having a Roth 401(k) makes any difference regarding tax.

Doesn't make any difference. You pay yourself back with interest, as it's supposed to be as if you never took the money out at all. If you want to game the system, charge yourself a ridiculously high interest rate on the loan from your Roth 401k to substantially up your Roth balance, you crazy 27 year old you. Then pray the IRS doesn't find out.

pianogirl wrote:Wouldn't this qualify as a hardship withdrawal with no penalty?

Like loans, hardship withdrawals must be allowed by your employer. But hardship is only a reason to take money out; it doesn't mean you automatically avoid paying tax or penalty. Most hardship withdrawals will still be taxed and penalized, and since you can't roll over hardships you can't take advantage of IRA-specific penalty exceptions.

nealric wrote:One hitch is that the loan is usually accelerated if you leave your employer. If you don't have cash on hand, that could cause a big early withdrawal penalty (likely destroying the remaining 50%).

Good point, but you'll get 60 days from the time it's considered distributed to roll in whatever you can to an IRA to limit the tax consequences. For example, if you have a 20K loan balance and leave your job, you could put 8K into an IRA within 60 days and only be taxed/penalized on 12K.

09042014
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Re: Math is hard. 401(k) loan to pay down debt?

Postby 09042014 » Tue Mar 26, 2013 8:33 pm

thesealocust wrote:But an idea just struck me - would it be potentially advantageous to contribute money to a 401(k) plan, then take a loan against your 401(k) and use that money to pay down student debt?

It could theoretically allow you to shovel pre-tax dollars into your student loans, couldn't it?

This is a very complex question, and I'm about to go to bed so I can't run through all the math / tax implications / laws, but has anybody out there already thought about this?


Won't you just have to pay it back with post tax money later?

glennB
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Re: Math is hard. 401(k) loan to pay down debt?

Postby glennB » Mon Oct 06, 2014 10:37 am

SPAM

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XxSpyKEx
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Re: Math is hard. 401(k) loan to pay down debt?

Postby XxSpyKEx » Mon Oct 06, 2014 1:04 pm

I'm failing to understand how this is truly using tax-free dollars to repay your loans. Say, for example, you take out $50k from your 401(k) to repay your student loans through a 401(k) loan. Then you immediately repay that 401(k) loan with $50k in post-tax dollars. How is that any different than simply paying the $50k on your loans with post-tax dollars? I mean if you wait to repay it for a year, then you avoid paying $4k in interest on that $50k (assuming 8% interest), but you also "lose" the interest that $50k would have gotten across the year from the stock market (if you had kept it in the 401(k)), which might have been a lot more than 8%. This strategy only seems to work out in a situation where your 401(k) is either not generating interest or losing money during the year -- what am I missing here?

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patogordo
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Re: Math is hard. 401(k) loan to pay down debt?

Postby patogordo » Mon Oct 06, 2014 1:08 pm

I think the idea is that the interest rate on your loans is likely higher than your rate of return in the market. still seems like a pretty marginal benefit though, considering the risk of tax penalties if you fail to repay




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