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We are thinking of borrowing from my 401k(has a balance of ~$165k) to pay off about $10k in debt which has an average interest of 18%. Is this a good idea? Below is from my 401k website. Thanks very much for the help.


Plan Rules for General Purpose Loans

Maximum Amount Allowed:$50,000.00

Minimum Amount Allowed:$500.00

Incremental Principal Amount:$100.00

Current Interest Rate:3.25%

Application Fee:$20.00

Maximum Payment Amount:No Limit

Minimum Repayment Term:12 Months

Maximum Repayment Term:60 Months

Incremental Repayment Term:1 Month

Annual Maintenance Fee:$10.00
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Hi, a couple of very quick questions.

Is the interest rate set, or does it fluctuate according to the market?

Is you company one of those that requires immediate payback if you resign or are terminated?

Nancy
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I will check about the interest rate. I am in the Union and have not been unemployed in all of my career with the Union. I am in the office......the field guys get laid off a lot. I will check on that too.
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Theres too much risk in borrowing from your 401k. If you lose your job have to pay the money back with after tax cash or pay the penalty. The stock market should return better than 3.25 %

Look into your area and see if there are any credit unions that offer personal loans. In Phoenix at Sunwest Federal Credit Union they are offering a personal loan special of 7.90% for any reason. If you have money in CDs at a CU you can borrow against them and get a low rate.
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I am never in favor of taking money out of your 401k unless you have exhausted every other option and are in danger of being hauled off to debtor's prison.

Fuskie
Who wants to hear that you have tried everything to pay down this debt and aren't just overwhelmed and looking for a convenient way out...
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We are thinking of borrowing from my 401k(has a balance of ~$165k) to pay off about $10k in debt which has an average interest of 18%.

First of all, a 401(k) loan is NOT paying off your debt. It's moving it from one loan to another.

Now, I have more questions than Nancy.....

- Have you stopped using the credit cards completely?
- Have you resolved the spending issues that resulted in the debt?
- Will you be able to continue contributing to the 401(k) plan if you borrow against it?
- How long will you get the loan for?
- How long will it take you to pay off the debt if you don't get the 401(k) loan?
- How much are you putting toward the credit card debt/month now?
- Are you paying more than the minimum payments?
- What would the payments on the 401(k) loan be?
- Have you tried cutting back to pay off the debt?
- Have you asked your credit card companies for lower rates?
- Have you looked at balance transfers for the debt?

At your $160k (combined) income level, $10k is not that much, even though it's at 18%. Your minimum payments are probably in the $200/month range, right? If you could double that payment to $400, you could pay off the debt in 32 months. If you could pay $500/month toward the debt, you could pay it off in 24 months. If you could pay $1000/month toward the debt, you will have it paid off in 12 months. And just to put it in perspective, $1000 is only 7.5% of your gross income - a little less than you & your wife pay in SS/Medicare (7.65% combined). Since you probably are approaching, or just reached, the SS limit on your pay, you should have some extra money in your paycheck for the rest of the year to put toward paying down the debt.

I would strongly suggest that you look at other options for actually paying off this debt before you borrow from your 401(k), especially if you are still using the credit cards and/or have not resolved the spending issues that resulted in the debt. Paying off credit cards with a 401(k) loan if you can't answer 'yes' to the first 2 questions I asked will just free up more credit for you to charge up again.

AJ
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I'm going to sail upwind a bit.

I'm not convinced that borrowing from a 401k is always a bad idea automatically. If the market is going to flat or down, you could actually come out ahead. Yes, you lose on potential investment gains on the borrowed amount, but conversely you're insulated against investment losses as the same time. Any interest you pay in is added to your balance - you're paying yourself that interest, not a bank.

Borrowing is essentially a hedge against a bear market. I wish I'd had the foresight to borrow $100k (or more) from mine back in August 2008. Would have saved me from the 35% dip in the market that came the next month. Then again, my crystal ball is pretty fuzzy, and I often have trouble making these things out.

Like everyone else says, there is risk, mainly associated with job loss. You also have to consider the cash flow needed to repay the loan. If you're having trouble sliding into cc debt, what makes you think you can afford to add a 401k loan repayment to your budget without further backsliding?
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jeffbrig,

I agree with the overall meaning of your post, but the engineer in me has to pick a nit. You said: I wish I'd had the foresight to borrow $100k (or more) from mine back in August 2008.

You don't have to borrow money to insulate yourself from a bear market. Most 401(k)'s have a fixed income option that is essentially just a savings account with crazy-low interest rates. So, you could just transfer money to that account rather than a stock mutual fund and insulate yourself without the hassle of borrowing from your account, and then repaying it.

-Agg97
engineering neurotic
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I'm not convinced that borrowing from a 401k is always a bad idea automatically.

Neither am I. I've thought about borrowing from my 401(k) recently, too, in order to purchase some investments that I'm not able to purchase in my 401(k). If there is a contingency to cover the risks of leaving your job, it can be a feasible option.

But in this case, we don't know that the OP has resolved the issues that caused them to build up the debt. If they are still living above their means (significant though those means appear to be), borrowing from a 401(k) is just going to free up the cards for them to charge up again, so they can get deeper in debt, instead of paying off debt.

I wish I'd had the foresight to borrow $100k (or more) from mine back in August 2008.

I'm going to pick another nit. Federal law limits the amount that can be borrowed to 50% of your vested balance, or $50,000 - whichever is less, minus the maximum principal balance of any loan outstanding in the prior 12 month period. So, there is no way that you could have borrowed $100k or more.

Would have saved me from the 35% dip in the market that came the next month. Then again, my crystal ball is pretty fuzzy, and I often have trouble making these things out.

Of course, if you had borrowed in early 2009, after you'd already had the 35% decline, you could have also missed out on some big gains. That's the thing about market timing with fuzzy crystal balls.

AJ
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Any interest you pay in is added to your balance - you're paying yourself that interest, not a bank.

But you end up paying taxes twice on the money you're putting back into your 401K - you're repaying the 401K loan with after-tax dollars, and once you hit 59.5 and can withdraw, you pay taxes on money you withdraw from your 401K - so you end up paying taxes 2X on that portion of money you borrowed from the 401K.
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But you end up paying taxes twice on the money you're putting back into your 401K - you're repaying the 401K loan with after-tax dollars, and once you hit 59.5 and can withdraw, you pay taxes on money you withdraw from your 401K - so you end up paying taxes 2X on that portion of money you borrowed from the 401K.

Double-taxation is a red herring.

You are getting money out of your account without having to pay any taxes, so there's an offsetting tax benefit that you've realized on the amount withdrawn.

Net/net, there is no difference in the income taxes the OP would pay this year whether or not they take out the 401(k) loan. No increase in taxes paid => no double taxation

When the money is withdrawn, the amount withdrawn is what drives the income taxes, not the source of the money. If you are taking more than a required minimum amount, you are choosing the amount to take, so no change in taxes => no double taxation.

If you are only taking out the RMD, so the amount you have to withdraw is being dictated to you, then there is a possibility that you could pay more in taxes:

- If the interest (minus any fees) that you paid when paying back the loan is the same as whatever you would have gained during the same timeframe if you hadn't taken out the loan, there is no change in the RMD, so no change in taxes, up or down.

- If the interest (minus any fees) is less than you would have gained, then you are actually paying less in taxes.

- Only if the interest (minus any fees) is more than you would have gained (like if jeffbrig's wish to have borrowed money in 2008 had occurred) will you end up paying more in taxes than you otherwise would have. However, you will also end up with more money in your pocket after taxes. So, even when paying extra taxes, you end up better off than you would have if you hadn't taken out the loan.

With all that said, it's not a good idea to borrow money out of a 401(k) to pay consumer debt if

(1) you haven't resolved the issues that got you into that consumer debt and

(2) you don't have a contingency plan in place to pay off the 401(k) loan if you leave your job, either voluntarily or involuntarily.

AJ
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Net/net, there is no difference in the income taxes the OP would pay this year whether or not they take out the 401(k) loan. No increase in taxes paid => no double taxation

I'm not talking about an increase in income tax due to taking money out of a 401K.

The money in my 401K right now is all pre-tax dollars. If I wait until I'm 59 to start taking money out of it, I will pay tax on what I withdraw.

If I take a loan out on it today - I have to pay back the loan with dollars that I've already paid taxes on - so then my 401K becomes a mix of some money that's pre-tax, and some that was to pay back a loan and is therefore post-tax. And then come 59 when I withdraw I get to pay taxes again on those post-tax dollars in my 401K.
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MetroChick:

<<<Net/net, there is no difference in the income taxes the OP would pay this year whether or not they take out the 401(k) loan. No increase in taxes paid => no double taxation>>>

"I'm not talking about an increase in income tax due to taking money out of a 401K.

The money in my 401K right now is all pre-tax dollars. If I wait until I'm 59 [1/2] to start taking money out of it, I will pay tax on what I withdraw.

If I take a loan out on it today - I have to pay back the loan with dollars that I've already paid taxes on"


which also true of the credit card loans that are being replaced, so no difference or extra tax.

" - so then my 401K becomes a mix of some money that's pre-tax, and some that was to pay back a loan and is therefore post-tax."

It does not establish basis, so I diagree with the post-tax conclusion; it is like ineterst earned on a bond owned by the 401-k.

"And then come 59 [1/2] when I withdraw I get to pay taxes again on those post-tax dollars in my 401K."

You get to pay pay taxes on all the dollars coming out, whether you pay your self interest (from borrowing) or not.

Regards, JAFO
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If I take a loan out on it today - I have to pay back the loan with dollars that I've already paid taxes on - so then my 401K becomes a mix of some money that's pre-tax, and some that was to pay back a loan and is therefore post-tax.

1.) Withdraw pre-tax money. Spend it as post-tax.
2.) Repay with post-tax, which becomes pre-tax.

There is no double taxation on the principle.

There is double taxation on the interest, but interest paid on a consumer loan is also paid with taxed funds. There is no difference in the result.
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Most 401(k)'s have a fixed income option that is essentially just a savings account with crazy-low interest rates.

Fair point. But because of that crazy-low interest rate (approaching zero), the 3-4% one might repay their "loan" in interest could actually put more money in than the fixed income fund.
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Federal law limits the amount that can be borrowed to 50% of your vested balance, or $50,000 - whichever is less,

Which only underscores the reality that I've never seriously considered a 401k loan, just mused about it a couple of times.
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