UnThreaded | Threaded | Whole Thread (20) | Ignore Thread Prev | Next
Author: aj485 Big gold star, 5000 posts Feste Award Nominee! Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 74759  
Subject: Re: Simple question about 401k-to-IRA conversion Date: 2/25/2011 9:20 AM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 4
What it *actually* is is a withdrawal that you are required to pay back over time, along with a slight additional amount in a sum that is computed as if it were interest.

It *is* interest. A 401(k) loan converts part of your account into a bond-like instrument that you pay back over time, with gains at the fixed interest rate. If it wasn't interest, you wouldn't be paying back more than was withdrawn.

If you had $100K in the S&P500 fund and then took a $50K loan, and the S&P gained 10%, the value of your S&P holding would *not* be $110K----it would be $55K, plus a loan of $50k that is earning interest, for an effective total of $105k.

There, fixed that for you.

On the other hand, if the S&P 500 dropped by 10%, your 401(k) account would consist of $45k in an S&P 500 investment, plus a loan of $50k that is earning interest, or an effective balance of $95k, instead of $90k had you not taken out the loan.

As everyone notes, the "interest" isn't really interest, since you are paying it to yourself.

Doesn't matter if you are paying it to yourself - you will pay back more than you withdrew. You can title it 'interest' or 'investment gain' or 'additional money into your 401(k)' or whatever else you want - but it's still paying back more than you withdrew.

Also, a point that most people don't recognize about that "interest". You pay double tax on it.

This is a red herring. You pay no more tax in the year that you borrow the money, because *income* is what is taxed. The fact that you borrow money from your 401(k) does not affect your income.

When you go to withdraw the money, you pay no more tax on the withdrawal because you took out a 401(k) loan - the amount that you withdraw is taxed as income, no matter what the source was - interest that you paid yourself, or gains from other investments.

Since, over your lifetime, you will pay no more or less income tax whether or not you take out the loan, there is no 'double tax' paid.

The risk that needs to be taken into account when considering a 401(k) loan is the risk that it will turn into a non-qualified distribution, and therefore, will incur taxes and penalties on the remaining balance. In this case, that should be weighed against the additional potential cost of PMI and/or a higher interest rate on the mortgage, and the potential issuse of having a higher LTV loan if the house needs to be sold sooner than planned. There are risks and costs to every decision that is made - the OP will need to determine which decision has the more reasonable risks and costs for their situation.

AJ
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post  
UnThreaded | Threaded | Whole Thread (20) | Ignore Thread Prev | Next

Announcements

The Retire Early Home Page
Discussion on accelerating retirement day.
2013 Feste Award Voting Begins!
Who will win the 2013 Feste Award? Vote now for the Fool that most exemplifies the Fool Community mission of Learning Together!
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Post of the Day:
Tax Strategies

TMFPMarti-Feeling Good
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
Community Home
Speak Your Mind, Start Your Blog, Rate Your Stocks

Community Team Fools - who are those TMF's?
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and "#1 Media Company to Work For" (BusinessInsider 2011)! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.
Advertisement