Does anyone know if the interest you pay on a 401k loan counts towards your annual contribution limit? I can't seem to find any information online about this.

Let's say that a person is already contributing the maximum to both a 401k and an IRA. Could they contribute more by taking out a 401k loan and thus be paying interest on the loan? If so, you could take a $50,000 loan at say 5% from your 401k, then invest the proceeds. The point would be to match your 401k returns using the loan money.

Over a 5 year period this would add over $6000 in interest to your 401k account. If this is in addition to the max contribution AND you have matched your 401k returns with the loan money then you have avoided the major reasons not to take a 401k loan.

This probably doesn't work, but interesting to think about.

-Robert

Does anyone know if the interest you pay on a 401k loan counts towards your annual contribution limit? I can't seem to find any information online about this.

It does not - I can't reference anything in the law or tax codes on this but I can state that twice in the past I have had loans AND maxed my contributions to my 401K and no one had a problem with it.

If returns are low (like now) and you are looking to increase the money stashed in your 401K, this may be a "cheat" you can exploit.

The interest you pay on the loan is a kind of deemed earnings on the borrowed amount. The disadvantage to you of this is the interest you're paying is made with after tax dollars, but it does not create basis in your retirement plan...hence you're being taxed twice on the interest: after tax interest payments and taxed to you as ordinary income upon withdrawal. It does not count as part of your annual contribution limit.

The principal you pay back is also done with after tax dollars that will be taxable in the future to you as ordinary income when you make withdrawals. However, you were able to use pretax dollars for whatever you took out the loan for and did not have to claim the loan as ordinary income, so its a wash.

BruceM

Does anyone know if the interest you pay on a 401k loan counts towards your annual contribution limit?

No, of course not. Because you're not contributing to the plan, you're repaying a loan.

Keep in mind that some 401k plans limit your ability to make actual contributions to the plan after you take a plan loan. If that causes you to miss out on employer matching contributions, you're unlikely to come out ahead.

Remember the idea is to get OTHER people to pay you for the use of your money. Not to get you to pay you for the use of your money. So while you have the plan loan outstanding, the money is not invested and is not generating a return from other people/businesses.

Now you're going to tell me that you'll take the loan proceeds and invest them yourself. And from those investment earnings, you'll repay the loan. If you can do that, do it with something other than your 401k money. When you've beaten the returns on your 401k plan for 5 years running with something other than luck**, then you'll be ready to try this strategy. But by then, you'll already have a boatload of money in your investment account and you really won't feel like tapping into your 401k money.

Also, you don't get to set an artificially high interest rate. The plan will determine the interest rate. So you can't stuff extra money into the plan by charging yourself a very high interest rate.

--Peter


** Luck is something like having one stock that has such a big gain it wipes out all of the losses on your other 9 picks.

I think my point was lost in a couple of the responses. The idea is to reinvest the loan money, possibly in the same investments that it would have been in the 401k.

Also, the statement that 401k loans are "double taxed" is a myth:
http://thefinancebuff.com/2008/07/401k-loan-double-taxation-...

It's not generally a good idea to borrow money from your 401k because:

1. If you lose your job you will be forced to repay immediately or pay heavy tax penalties
2. Your investment returns will suffer as you have less invested
3. The interest isn't tax deductible, many other loan types are.

This hypothetical scenario has some advantages by:

1) If the investments you make with the loan money are liquid, they can be sold to pay off the loan at any time (e.g. you change jobs) and avoid penalties.

2) If the investments you make with the loan money are the same or at least have the same performance as your 401k, your not hurting your long term results.

The problems with this scenario seem to be:

1) It may be hard to match your 401k returns while dealing with trading costs and long/short term capital gains which aren't a problem in the 401k. You will likely have to sell regularly to make the loan payments.
2) If you lose your job or change jobs and are must pay off the loan, the timing may not be right to liquidate the loan investments.
3) At the end of the loan term, you might have more money in this approach, but any gains made from the loan money beyond the interest rate will be outside the 401k.
4) The higher the loan interest rate, the more appealing this approach is. This would be far more appealing at %20 than %5, despite the absurdity.

I am in no way recommending anyone do this. I'm just fascinated by what-if's like this.

-Robert

2. Your investment returns will suffer as you have less invested

In a falling market, this could actually be a positive. I wish I'd had the foresight to borrow $100k from my 401k a couple of years ago. ;)

... If so, you could take a $50,000 loan at say 5% from your 401k, then invest the proceeds....

I do not see where you would really gain anything.

If you have $100K in both a 401K and a taxable stock account you would have $200K invested. If you do this $50K loan, then you would still have a total of $200K invested ($50K in 401K and $150K in taxable) Any gains in the taxable account would be taxed and the interest repaid into the 401K will(on average) be less than the $50K would have earned if it was left invested in some sort of balanced mutual fund.

Not that it is a good idea, but you need to compare this to just buying on margin in your taxable account. If you were in the same situation and invested $50K on margin in the taxable account, then you would have $250K invested($100K in 401k, $150K in taxable).

Greg