Death and... Taxes.

Sanrith Descartes

Sanrith Descartes

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It's not bullshit, I 100% guarantee it's stated in the docs you signed for the loan what happens if you separate from the company before repaying it.

The tax on it will be at your normal tax rate. Also be advised your severance counts as income as well. Depending on when you plan to get another job and what your normal income is, you should do some napkin math on it. Usually most companies will withhold taxes out of the severance check, but double check they did so.

And Jysin Jysin Is correct on the 10% penalty for early withdrawal unless this qualified as a first time home purchase.
 
BrutulTM

BrutulTM

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Furry said:
I did a 401k loan so I could pay cash for my new car. 25k at ~1% interest (feb22) and like a 50$ fee, where all the interest comes back to me. I'm at the point where I'll just pay it back as a lump sum at the end of the year probably, like 8500 left. I probably could have paid it off faster, but felt it was just smarter to max my 401k/roth and let the loan ride. I had replaced the entire loan amount within 1 year, so the opportunity cost was fairly negligible.

If for some reason I lost my job and had to eat it as a disbursement, it really won't be a big deal. I view my roth as my emergency fund since I can withdraw the principle amounts without any penalty whenever I want, and that's closing in on 100k. And financially I viewed the 401k loan as superior to taking form the roth, because the roth money can't go back in, so I need a true emergency before diddling in that.

I don't think 401k loans are a bad idea at all if you are financially prepared for bad outcomes. If I had gone the traditional route of a bank/dealership loan I'd have spent more money.

Edit: And to say what I'd do in Koushirou Koushirou 's position. I'd eat the disbursement most likely. Semi depending on how big a number we're talking about. If you're unemployed, your tax burden will be pretty low most likely. Additionally, aggressively pursue a waiver on the 10% fee, because the money went to your primary residence. Doing that, you'll probably get the tax down to around 10-12% of whatever the amount is, which is payable next year. It shouldn't count as a default or anything like that. It's your money, and the payment you need to make is just the taxes next year.

From there, live cheap, find a job, and probably hire someone competent to do your taxes next year.
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Did you borrow from a Roth? My understanding is that if you take money out of a tax deferred account for more than 60 days you have to pay income taxes on it as well as paying a penalty?
 
Furry

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BrutulTM said:
Did you borrow from a Roth? My understanding is that if you take money out of a tax deferred account for more than 60 days you have to pay income taxes on it as well as paying a penalty?
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We borrowed against a 401k. There's no penalty if you repay it on the plan, which is typically 5 years. I think for primary residences it can be 10.

Roth money, you can withdraw your contributions at any time. There's only a penalty if you withdraw gains. Of course, the opportunity cost is huge, since typically you can't contribute more than the max a year, regardless of how much you withdraw.
 
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Khane

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BrutulTM said:
Yeah, don't borrow money from your 401k unless you can put it back within 60 days. Most expensive loan you can take out.
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This is, not true.

When I bought my house I had a huge, unexpected, catastrophic retaining wall failure next to my house that pushed mud and water throughout my basement. I couldn't afford to just pay for the new retaining wall + water remediation so I took out a 401k loan. It had a 60 month term, which was easy enough for me to pay off, and it was 0% interest. It's one of the BEST loans you can take out (if you don't lose your job with that company)
 
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Koushirou

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Sanrith Descartes said:
It's not bullshit, I 100% guarantee it's stated in the docs you signed for the loan what happens if you separate from the company before repaying it.
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Yeah, I'm sure it is. Obviously just wasn't something I considered when I got it originally, and TBH even if it was written in big ass bold letters and told to me over and over, it's not like it would have changed my original plans because I needed down payment money and that's what I had access to. Just a little salty with all the other bad shit happening to me right now. Just confused as to the why of it not being an option to just keep paying it back essentially at the same rate I was before, but it is what it is. And yeah, taxes were already withheld on the severance. This was for my first house, so I'll see about that waiver. That's for the input, everyone.
 
Furry

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Khane said:
This is, not true.

When I bought my house I had a huge, unexpected, catastrophic retaining wall failure next to my house that pushed mud and water throughout my basement. I couldn't afford to just pay for the new retaining wall + water remediation so I took out a 401k loan. It had a 60 month term, which was easy enough for me to pay off, and it was 0% interest. It's one of the BEST loans you can take out (if you don't lose your job with that company)
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Typically the interest is prime rate +1-2%, but you pay the interest to yourself. Not technically 0%, but better than pretty much any other loan since you are paying 0% to the bank.
 
BrutulTM

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I think I'm confusing a 401k with an IRA. You do have to consider the opportunity cost of having your money out of the market for 5 years. In that way it could cost you quite high interest vs a bank loan.
 
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Cad

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Furry said:
Typically the interest is prime rate +1-2%, but you pay the interest to yourself. Not technically 0%, but better than pretty much any other loan since you are paying 0% to the bank.
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If your 401k was going to make the market rate (~10% on average) and you could have borrowed the money at 4-5-6%, then no this is stupid to borrow from your 401k. It doesn't end up being that much since I don't think they let you borrow that much from your 401k, but this is basic interest rate arbitrage to not take your money out of high return situations and borrow at low interest rates if possible rather than spending your own assets.
 
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Furry

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Cad said:
If your 401k was going to make the market rate (~10% on average) and you could have borrowed the money at 4-5-6%, then no this is stupid to borrow from your 401k. It doesn't end up being that much since I don't think they let you borrow that much from your 401k, but this is basic interest rate arbitrage to not take your money out of high return situations and borrow at low interest rates if possible rather than spending your own assets.
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In this situation the appropriate rate of return to consider is more akin to 7%, and you are technically correct by their finest of margins in the even the market goes up precisely 7% per year, but the difference is so small between either choice it barely matters. The way I viewed it was I diversified a small portion of my retirement into a self serving bond which allowed me to own my car outright. I additionally won out, because the markets went down notably after the date I did that, so I definitely outperformed a loan in my situation.

Honestly though, you are correct to say borrowing against retirement is typically not a good idea for most people. As a general rule I’d say don’t unless the amount is trivial (<10%) or the need is truly pressing, eg khane’s scenario. I view buying a house as a perfectly acceptable reason though, as a primary residence is often the best investment someone can make, but I’d also stress someone doing that needs to be financially prepared for a bad event like losing your job.
 
BrutulTM

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Cad said:
If your 401k was going to make the market rate (~10% on average) and you could have borrowed the money at 4-5-6%, then no this is stupid to borrow from your 401k. It doesn't end up being that much since I don't think they let you borrow that much from your 401k, but this is basic interest rate arbitrage to not take your money out of high return situations and borrow at low interest rates if possible rather than spending your own assets.
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On top of that you're repaying the loan with after tax dollars which will be taxed when you withdraw the money. You're basically trading pre-tax dollars for after tax dollars that will now be taxed a second time. Also, with some plans, you can't make any contributions while you have a loan out. The interest rate that it says on the loan paperwork and the fact that you're paying it to yourself makes it sound like a smart move but it's really not. All of these losses compounded over 20 or 30 years would make your eyes bug out when you realize what that loan really cost you but you will probably never do that math.
 
Khane

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Keep in mind that the CAGR, or compound annual growth rate of the S&P500 is historically over 10% but that's year over year. Personal loans will be compounded monthly. Not really an apples to apples comparison.

Also, the type of person that needs a personal loan (regardless of where they get it) is typically not going to be the type of person getting a song on the interest rate. I'd be surprised if people with 7 figures in collateral could get personal loans in the 4-6% interest range, maybe they can but from quick googling a "normal" scenario for this (getting a loan through a firm like SoFi) is ~9%. And that's probably the rate for the "best" candidates.

The double taxation on 401k should, in typical circumstances, be negligible. It gets taxed as income on withdrawal after retirement and in theory your income will be relatively low.
 
BrutulTM

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Khane said:
relatively low
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"Relatively low" tax rates are way higher than loan interest rates.

No one should really be taking out personal loans from either a bank or their 401k unless it's an extreme emergency. If you're a homeowner you should have like $20k (more or less depending on where you are and how much your house costs) for an emergency fund and most other things you should just save up for.
 
Furry

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BrutulTM said:
On top of that you're repaying the loan with after tax dollars which will be taxed when you withdraw the money. You're basically trading pre-tax dollars for after tax dollars that will now be taxed a second time. Also, with some plans, you can't make any contributions while you have a loan out. The interest rate that it says on the loan paperwork and the fact that you're paying it to yourself makes it sound like a smart move but it's really not. All of these losses compounded over 20 or 30 years would make your eyes bug out when you realize what that loan really cost you but you will probably never do that math.
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When you borrow against your 401k there is 0 tax. It only gets taxed if it becomes a disbursement, but at that point you don't repay the loan. Any loan you pay back you're going to be paying back with post-tax dollars, so that part works like any other loan. As for the you can't make any contributions with a loan out... My plan doesn't work that way at all. Maybe there's some shitty ones out there that do that? I've never heard of that so I'm of the opinion you're just making that up.

As for the whole math thing, that's where every individual needs to assess their situation and look at the potential up and downsides. EG, what tax bracket are you in. A lower monthly payment with a 401k loan let me keep all my contributions at max, which lowered my tax burden, saved me interest costs, and the opportunity cost over the term of the loan was likely to be around 3-4K$ (ultimately it was in actuality NEGATIVE), especially since I can repay early. But for someone in a lower tax bracket, or who is saving less or has a lower total value in their 401k... the risk could easily become too high to justify it over a traditional loan.

So personally, not gonna side with 401k loans always good or bad. They are a tool that people should be aware of and use with restraint in justifiable situations.
 
Sanrith Descartes

Sanrith Descartes

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Koushirou said:
Yeah, I'm sure it is. Obviously just wasn't something I considered when I got it originally, and TBH even if it was written in big ass bold letters and told to me over and over, it's not like it would have changed my original plans because I needed down payment money and that's what I had access to. Just a little salty with all the other bad shit happening to me right now. Just confused as to the why of it not being an option to just keep paying it back essentially at the same rate I was before, but it is what it is. And yeah, taxes were already withheld on the severance. This was for my first house, so I'll see about that waiver. That's for the input, everyone.
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It's not an option because the IRS tax code that creates the ability of 401k accounts to exist doesn't explicitly state that severed employees can keep repaying as an option. And since companies don't have a mechanism in place to take in payments (while the the law doesn't specifically say payroll deductions it does say according to the plan and pretty much all plans use the exact same IRS approved template) and severed employees are no longer getting payroll to make deductions against, companies just decide to do away with rhe liability and headache and go with repayment or disbursement.
 
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Koushirou

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Sanrith Descartes said:
It's not an option because the IRS tax code that creates the ability of 401k accounts to exist doesn't explicitly state that severed employees can keep repaying as an option. And since companies don't have a mechanism in place to take in payments (while the the law doesn't specifically say payroll deductions it does say according to the plan and pretty much all plans use the exact same IRS approved template) and severed employees are no longer getting payroll to make deductions against, companies just decide to do away with rhe liability and headache and go with repayment or disbursement.
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This helps it make more sense. Thanks.
 
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