Borrowing against 401K - Thoughts? - Mothering Forums

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Old 12-27-2008, 05:27 AM - Thread Starter
 
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What are your thoughts on borrowing against 401K? My DH has over $13K in 401K now, which is all from the past year. We're thinking of using some of that to supplement a down payment on a house toward the end of 2010. We're 26, so retirement is definitely not imminent or anything. We'll be saving around $15K in our own savings account, and we hope to get around $10K from the 401K for a total down payment of around $25K. Is this a good or bad idea?
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Old 12-27-2008, 05:52 AM
 
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To me, it would make more sense to suspend all deposits into the 401K right now, and instead put all that money into your downpayment savings. Since you have 2 years to save, it may very well be possible for you to make your goal of 25K if you divert all extra money to that savings fund. If you did that, you wouldn't have to worry about paying back the 401K money on top of trying to pay on your mortgage.

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Old 12-27-2008, 05:53 AM
 
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Suze Orman strongly warns against it:

Also, never ever borrow against your 401k plan because you will pay double taxation on the money you borrow. Because you don't pay taxes on the money you put into a 401k, when you pay back the loan (which you must do within five years, or 15 years if used to buy a home), you pay it back with money you have paid taxes on. Then, when you retire and take the money out again, you end up paying taxes on it a second time. And that isn't even considering the penalties you have to pay if you change jobs/quit/lose your job, in which case the money is due immediately and subject to taxes and a 10% penalty.

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Old 12-27-2008, 01:06 PM
 
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I wouldn't touch it unless it was a dire emergency and there were no other resources to tap.

Just about every financial expert will tell you not to tap it for a down payment. As Annethcz suggested, try suspending your 401k contributions. If DH's employer matches and you contribute more than required to get the match then lower the contribution just enough to still get the match and use the other money to save towards your down payment.

Also, do your research now on what type of house payment you want to afford. When DH and I bought our house 10 years ago we knew what we could afford and did not buy the max amount that the bank would loan us. The bank tried to get us to purchase a more expensive house because, according to their calculations, we could afford more but we knew our budget and went with a less expensive house. We love it and we love our lower payment. We're not house rich and cash poor. We have wiggle room which has allowed me to work part time while our son is little.

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Old 12-27-2008, 03:48 PM
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Originally Posted by griffin2004 View Post
Suze Orman strongly warns against it:

.
But it's a "Brave New World." (strange economy...the old rules don't necessarily apply.)

You DON'T pay taxes when you take out a 401k loan.........only when you take out a 401k distribution (I know, I've done both.)

(I mean you don't pay extra taxes on a loan.......it's not considered new income when you take out a loan.)

I'd do it. The market could tank considerably next year and the balance you think you have now could go down quite a bit. "A bird in the hand is better than two in the bush."

Actually if you're going to use it toward a house you may be able to take a distribution rather than a loan (then you wouldn't have to pay it back.) With a loan there is the risk of losing your job and then having to pay it back immediately. We took a medical distribution from my 401k to pay for my dd's braces. I considered that a much better "investment" than letting it sink in this stock market.

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Old 12-27-2008, 04:15 PM
 
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I took out all the money in my 401K as a distribution to buy a house and I got hammered on taxes and penalties. I would not make that choice again. l ended up losing about 35% of the amount I took out when you factored in the penalty and taxes.
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Old 12-27-2008, 06:35 PM
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Originally Posted by griffin2004 View Post
Suze Orman strongly warns against it:

Also, never ever borrow against your 401k plan because you will pay double taxation on the money you borrow. Because you don't pay taxes on the money you put into a 401k, when you pay back the loan (which you must do within five years, or 15 years if used to buy a home), you pay it back with money you have paid taxes on. Then, when you retire and take the money out again, you end up paying taxes on it a second time. And that isn't even considering the penalties you have to pay if you change jobs/quit/lose your job, in which case the money is due immediately and subject to taxes and a 10% penalty.
My question is, if you have a 401k and lost a huge amount of money can that help you get your taxes down? I know you pay on capital gains so why not beneift tax wise from he lost of money. I know many lost 50 percent of their 401 k this year. That means if they had $400 k and now have $200 k would they be able to take money out and not have to pay taxes being they lost so much money? How does it work?
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Old 12-27-2008, 07:12 PM
 
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Unfortunately for most withdrawing from retirement account now, you can't take a loss on funds in you retirement accounts. You pay on capital gains in a regular, taxable, non-retirement accounts, but in tax deferred retirement accounts like a traditional IRA or 401(k)/403(b) accounts, you pay regular income tax on your withdrawals (not capital gains tax) and you cannot use a loss in that account to offset taxes or other capital gains.

Your idea would apply if you had money in a regular taxable account of stocks, mutual funds etc tho.

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Old 12-27-2008, 07:16 PM
 
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I wouldn't do it. You should be able to save for the house AND save for retirement. Suspend contributions, sure, but don't borrow for the down payment.
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Old 12-27-2008, 07:41 PM
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I took out all the money in my 401K as a distribution to buy a house and I got hammered on taxes and penalties. I would not make that choice again. l ended up losing about 35% of the amount I took out when you factored in the penalty and taxes.
I know it's a hit, but when you say you "lost 35%," that really assumes the market would stay stable or go up (and therefore you'd make the same or more money in the market). That's really a shaky assumption at this point in time.

If you leave money in your 401k, you only have it on paper. If you take it out (as a loan or distribution), you have it in hand, at least a good chunk of it.

Also, if you take money out of your 401k and therefore can lower your house payments (or have payments for fewer years), you're saving A LOT of money on compound interest over the life of the mortgage. That's something to consider, as well.

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Old 12-27-2008, 07:43 PM
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Unfortunately for most withdrawing from retirement account now, you can't take a loss on funds in you retirement accounts. You pay on capital gains in a regular, taxable, non-retirement accounts, but in tax deferred retirement accounts like a traditional IRA or 401(k)/403(b) accounts, you pay regular income tax on your withdrawals (not capital gains tax) and you cannot use a loss in that account to offset taxes or other capital gains.

Your idea would apply if you had money in a regular taxable account of stocks, mutual funds etc tho.

Thanks for the information. It seems counterproductive to loose as much as $200,000 in an 401 k and then have to pay taxes if you take some out for a house payment or other needs. It almost forces you to keep your money in there which may be hard if you feel that more of it is going to be washed away. I guess one just keeps in it there hoping that someday its value will go back up.:
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Old 12-28-2008, 04:19 AM - Thread Starter
 
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I should add that all of DH's 401K money goes into a stable fund, so we're not losing anything as the stock market plummets.
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Old 12-28-2008, 03:49 PM
 
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I once took out $20,000 to use as a downpayment on a home. I just looked at it as trading one investment for another. The house appreciated in value and I was able to build the 401k back up over time. My calculations showed I did not lose out by doing this, as the house appreciation made up for any 401k losses and the $20,000 was simply sitting as equity in my home instead of sitting in my 401k.
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Old 12-28-2008, 05:28 PM
 
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My question is, if you have a 401k and lost a huge amount of money can that help you get your taxes down? I know you pay on capital gains so why not beneift tax wise from he lost of money. I know many lost 50 percent of their 401 k this year. That means if they had $400 k and now have $200 k would they be able to take money out and not have to pay taxes being they lost so much money? How does it work?
The reason that you would pay taxes when taking $ out of a 401K, even if you've lost $, is that you would have deducted the amounts you contributed to the 401K the year you made those contributions. So you have no "basis" in the amounts in the plan. If you had the money in a regular taxable account, you would only be taxed on the gains. But since you've never paid taxes on the $ that's in the account, you owe when you take it out. That is why it's better (from a tax perspective) to take $ out of a Roth IRA, because your contributions to the fund have already been taxed. The reason it's such a whack to take the $ out of a 401K is that in addition to the taxes you pay, you also have to pay a penalty.

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Old 12-28-2008, 05:31 PM
 
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I should add that all of DH's 401K money goes into a stable fund, so we're not losing anything as the stock market plummets.
So is it in a money market fund? That works out nicely during this current situation, but no financial advisor would ever suggest that you keep all of your retirement funds in such a low return vehicle...for the long term that is. Once the stock market picks up, you won't go anywhere.

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Old 12-29-2008, 12:19 AM
 
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Borrowing against 401K - Thoughts?


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Old 06-04-2009, 11:21 AM
 
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I think A LOT of people refuse to realize that borrowing against the 401k and withdrawing from the 401k are very very different. Even Suze has misinformation about this.
Quote:
...if you change jobs/quit/lose your job, in which case the money is due immediately and subject to taxes and a 10% penalty.
this is 100% wrong because of ONE word. The money is due immediately OR subject to taxes and a 10% penalty, these are two very different statements.

Borrowing against 401k is a risk, but most 26 year olds do not have a 401k, and 99.999% of all investment advice out there is for the 40+ crowd, so there are no "one size fits all" rules for a 20something with a 401k in my opinion. (I am not a fan of one-size financial advice, because it is stupid to follow blind advice when you have access to the real numbers for real math.)

People hate paying income tax. Given the opportunity, they will OFTEN make STUPID financial decisions in order to avoid paying it, for any reason. Case-in-point... mortgage meltdown. One of the biggest reasons I saw for people buying houses when they really weren't in the position to do so was "But you are throwing your money away on rent, and there are huge tax advantages to home ownership". People focus much more on where their money goes more than on HOW MUCH, which is pretty much the worst idea ever.

The truth is, it is easier for the typical person to grow a 401k than it is a savings account, for a myriad of reasons... It is pre-tax so you spend 150 to deposit 200 (assuming no company match), it is hard to withdraw, so you won't, it is hard to borrow, so you will wait untill you actually need to, it comes directly out of your check, so you don't "forget" to budget it. Once you do borrow, it is also automatically paid back from your paychec *gasp* after tax, plus you are still contributing pre-tax, so your balance grows even faster.

I think only you can make the decision, but you should do it with your eyes open
1) Will you save the money even if you are not "forced" to in your 401k?
2) How well is your 401k performing, better or worse than the interest rate you will be paying yourself on the loan? If it is performing better, then this will have a negative effect on your retirement balance in the future (even if minimal, you should look at how much it will hurt you in the future; if the interest rate is higher, then you will be affecting a positive change in your future balance, at the expense of your budget at age 26, are you ok with that?
3) Are you ok with the payment terms? The repayment of a 401k loan comes out of your paycheck, and you need to make sure that your homeowner budget takes that into account.
4) Double taxing, you are consciously making the decision to pay the government for the right to borrow money from your own tax deferred asset. Paying the government more than you absolutly have to drives some people crazy, are you going to be ok with it?

Retirement savings are about feeling the burn when you are young so you don't have to when you are old. If you CAN handle it at age 26 and this is the plan that you are walking in to, rather than an impulse with unintended consequences, then well, you have made a financial decision that you can live with.
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Old 06-04-2009, 11:26 AM
 
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We do it. Actually, I've taken a loan out against my TSP (401K for gov't employees) twice in the last 8 years. I pay myself back with interest, and I am not taxed on the money I am paying back. I've made more interest off myself than I have off most of the investments my retirement money is in (eta: in the last few quarters). For me, it makes total financial sense to lend myself money, especially in an economy where my savings aren't making much money on their own.

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Old 06-04-2009, 11:31 AM
 
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also, At what point do the much feared "double taxing" and the much revered "Tax benefits of home ownership" cancel each other out?

hint: I am pretty sure you will be paying less tax overall, but be spending more money overall.
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Old 06-04-2009, 11:58 AM
 
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: Dh and I were just considering whether or not it's be smart to finish off our mortgage out of 401k (and whether it's even possible...), because we're worried about the performance of the stock market over the next few years, as well as the stability of the dollar...

ETA... we actually have been gaining a lot in our 401 k since the crash, though... apparently chinese mutual funds are doing quite welll. I was SHOCKED, to say the least...

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Old 06-04-2009, 03:57 PM
 
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I'd do it. The market could tank considerably next year and the balance you think you have now could go down quite a bit. "A bird in the hand is better than two in the bush."
I had to check the date stamp on this post. The stock market has already tanked. To take money out now would be selling at the bottom of the market, which is always a bad idea.

Personally, I'd leave it there, alter my 401k contribution to be just the minimum to get any match that's offered and save for a downpayment normally. Use the time to get your credit score as good as possible, and to eliminate debt.

The amount you need for a downpayment varies with the cost of the house. Closing cost are 2-5% of the loan + an emergency fund of at least $10,000 to cover unexpected expenses + downpayment of at least 3.5%. On a $300,000 house that's $35,000, on a $100,000 house it's $20,000. And you should also consider whether PMI is worth it, or if you should wait until you have 20% to put down.
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Old 06-04-2009, 04:00 PM
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I had to check the date stamp on this post. The stock market has already tanked. To take money out now would be selling at the bottom of the market, which is always a bad idea.
Yeah, you're quoting me from six months ago. But there's no guarantee the market won't tank more.

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Old 06-04-2009, 04:42 PM
 
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Originally Posted by ShaggyDaddy View Post
also, At what point do the much feared "double taxing" and the much revered "Tax benefits of home ownership" cancel each other out?

hint: I am pretty sure you will be paying less tax overall, but be spending more money overall.
If you're buying a house for about $150K or less, and have reasonable property taxes, the "Tax benefits of home ownership" can be rather overrated since there isn't necessarily a huge difference between itemizing home ownership deductions (ie. home taxes and interest) and taking the standard deduction. For many people who buy less expensive homes, they actually do better taking standard than itemizing, so no advantage to having mortgage interest for them.
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