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

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anonnymouse
Posts: 173
Joined: Tue Mar 08, 2011 3:52 pm

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

Postby anonnymouse » Mon Oct 06, 2014 5:49 pm

XxSpyKEx wrote: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?

The main benefit is that you pay interest to yourself rather than to whoever holds your student loan notes. You miss out on the potential upside of $50k invested in whatever target you had selected in your 401k. On the other hand, if your previous investment target goes down in price while you're repaying the loan, you stand to benefit since your repayments buy more of that target now.

Or, think of it as liquidating $50k of one asset in order to buy a $50k bond in yourself.

bdubs
Posts: 3729
Joined: Sat Feb 06, 2010 2:23 pm

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

Postby bdubs » Mon Oct 06, 2014 5:57 pm

The only benefit I see here is that if you were planning to divert all of your disposable/investable money into paying your loans, this would also allow you to make 401k contributions in your repayment years. I.e. If you don't put money in a 401k in 2014, your contribution limits for that year are forever lost. However, if you max out your contributions in 2014 and were able to take out a loan for the same amount to repay loans then you can effectively recapture the contributions from 2014 and still pay down your loans just as quickly. Effectively this allows you to shift a dollar invested tax free today into a dollar invested in several years, also tax free.

FYI - you usually can't get a loan from a 401k plan where you no longer work, and you can't take a loan out from an IRA.

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XxSpyKEx
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Joined: Wed Dec 27, 2006 5:48 am

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

Postby XxSpyKEx » Mon Oct 06, 2014 6:18 pm

anonnymouse wrote:
XxSpyKEx wrote: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?

The main benefit is that you pay interest to yourself rather than to whoever holds your student loan notes. You miss out on the potential upside of $50k invested in whatever target you had selected in your 401k. On the other hand, if your previous investment target goes down in price while you're repaying the loan, you stand to benefit since your repayments buy more of that target now.

Or, think of it as liquidating $50k of one asset in order to buy a $50k bond in yourself.


patogordo wrote:I think the idea is that the interest rate on your loans is likely higher than your rate of return in the market


So basically the only time that this might make sense is when you're predicting that your investments/the market will decline over the course of the next year. I dunno, overall, this seems pretty risky and that the potential losses (in both opportunity costs and the risk of having to immediately repay if you leave your current employer (or pay large penalties)) outweigh the potential benefits (especially since you're going to experience double-taxation on the interest that you repay to yourself).

bdubs wrote:The only benefit I see here is that if you were planning to divert all of your disposable/investable money into paying your loans, this would also allow you to make 401k contributions in your repayment years. I.e. If you don't put money in a 401k in 2014, your contribution limits for that year are forever lost. However, if you max out your contributions in 2014 and were able to take out a loan for the same amount to repay loans then you can effectively recapture the contributions from 2014 and still pay down your loans just as quickly. Effectively this allows you to shift a dollar invested tax free today into a dollar invested in several years, also tax free.


This seems to be the same thing that others have been saying. The problem I have with it is that it seems to completely ignore the time value of money and the lost opportunity cost of not having that money gaining interest in your 401k during the years that it was taken out of your account. Obviously, if your investments were not going to gain interest or losing money during the years that the money was taken out, then it might make sense. But, if it's a year like last year, and you're losing something like 30% interest on your 401k funds, then it doesn't really seem to make much sense, unless there's something I'm missing here...




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