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Financial Planning / Foolish 401(k)s


Subject:  Re: paying back 401k Date:  6/5/2007  12:44 PM
Author:  DeltaOne81 Number:  21995 of 26351

Yes, you should pay it back, and let me explain why.

The counter-intuitive thing is that the interest rate on a 401K loan is nearly irrelevant. You're paying interest to yourself (well, your 401K) so its not really costing you anything, its just moving money from one pocket (your paycheck) to another (your 401K).

However, the *real* cost of your 401K is in lost returns. The interest, dividends, and capital gains that you would earn on the money. The cost of this varies from year to year depending on the market, but, on average, chances are, will be around 10%. That's a pretty expensive loan.

But, as you may point out, you have the money invested right now in a brokerage account. Well, that may add another level of thought, but, to me, makes the answer even more conclusive. Assuming that the category of equities you are invested in the taxable account is reasonably equivalent to the types of funds you would have in the 401K, then the main difference is that you are currently paying taxes on any gains, and in the 401K all that would be tax deferred (if this assumption doesn't hold, then the question becomes much messier). So, the only difference between keeping the money in your brokerage and using it to pay of your 401K, is that here the gains are taxed immediately, and there they are tax deferred for years.

Seems to me moving the money back into your 401K is the answer.

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