Cracking Into Your Nest Egg Early

Not Double-Taxed

I disagree regarding getting taxed twice. You're forgetting that you never got, nor ever will get, taxed on the 401(K) loan amount you took out. Think of it this way > if you took out a $10K loan (which is untaxed $) & immediately repaid it w/ the $10K you just took out then you would never have paid w/ taxed money (your salary). That $10K, now safely back in the 401K, would get taxed whenever down the road you decide to withdraw. If you think of re-paying the $10K w/ "separate" income you make (ie., taxed dollars) then, yes, that money will be taxed twice. But you're forgetting the $10K you took out which will never get taxed. The only double-tax I see is on the interest you pay on the 401(K) loan.

ben of NH @ Mar 30, 2009 15:25:55 PM

401k vs IRA discussion

I would welcome comment on the following:

What if the 401k lost and is losing money and one has credit card debt running at anything from 4.8% to 29%pa on amounts for instance of say 4k to 30k? Or if one is going or nearly going into foreclosure on ones prime home? What is the sense considering to almost 'bankrupt' oneself in order to bleed -6%pa?

Many people have lost the equivalent amount that could have paid down considerable amounts of the credit card debt but what's done is done why should they be penalized in making an effort to become financially stable with a home by using some or all of their 401k. Let's say this 401k is with an old employer and not the current one which contributions to the max are being made.

What other investments can be made with an IRA and not a 401k, ie can one buy land, or resl estate and just 'sit on it' until retirement or infact us real estate buying and selling for the IRA investment instead of mutual funds? How can one reconcile ones debt situation with ones retirement and tax situation today?

simmons of NC @ Mar 17, 2009 12:36:50 PM

401k Loans - Worst Idea Ever!

Here's how bad it is:

Accumulate 401k positions with each contribution of deferred pre-tax money, at different cost bases.

Take a loan: Many plans require First-In/First-Out liquidation of positions accumulated, first from pre-tax and then from (see plan docs). If the original NAV (cost basis per share) went up since purchase of first-in holdings, then just enough First-In shares will be sold so as to fund the loan from original cost bases and realized gains. Worse for if market declined, then losses on deferred pre-tax funded first-in purchases, will be realized.

The loan principal comes from deferred pre-tax original cost bases and gains (or losses realized if market declined). Note, 401k positions are not held in a borrower-risk-free margin-like account and restored upon periodic repayments of interest and principal. This is analogous to how a loan might be offered through an IRC 409A defined benefit (i.e., retirement pension) plan (as opposed to a defined contribution 'savings' plan, such as a 401k).

401k Loan principal gets distributed as a loan, and is to be repaid at a stated interest rate, first to periodic loan interest and then to periodic principal. Repayment is typically from auto payroll deduct and gets allocated to various investment choices according to the 401k-owner's contribution allocation decision. IRS states the repayment to be no more infrequent than once every 3 months, else a taxable distribution event (with possible early age penalties, too). Leave the company and you must immediately repay or incur a realized taxable distribution.

After-tax funds are used to repay loans. Hence, not only did the porfolio within the 401k change, but also did its tax-characterization. The original cost basis was tax-deferred, and as such, a double-taxation will occur when distributions are eventually taken. This double taxation will first have occured on the money used to repay the 401k loan (near term), and then on the eventual distribution of the proceeds from the positions bought upon loan repayment (distant future).

IRC 72p spells out the taxation aspects of 401k/403b/457 loans. However, companies are loathe to provide a real calculator to show the TRUE cost (including opportunity cost of appreciation, revised holdings, loan interest, and tax whammy) of a loan. Bankrate.com has such a calculator. But you don't need to beat a dead horse!

EmilyB'zAQT of DC @ Jul 31, 2008 19:13:42 PM

401(k) Loans

One of the pieces of important information that appear to be left out in so many of the aritcles I've read regarding the problem in taking 401(k) loans is that assuming the employee makes regular payments, the employee is ulimately paying taxes twice on that loan money:

First, when repaying the loan and interest because the repayments are made with after-tax money, and

Second, when the employee does take a distribution from the plan at retirement (or termination).

Since the advantage of 401(k) plans is that employees can defer paying taxes until the money is distributed, it has always seemed to me that taking a loan and then having to repay that loan with after-tax dollars is defeating the purpose of a tax-deferred retirement plan.

Just a thought...

Wendy Curto of IN @ Jul 28, 2008 12:29:35 PM

The maximum term is not 15 years

It's true that a common example given for residential loans is 15 years, but The ERISA Outline Guide, recent loan policies I've seen, and my understanding of the regs is that "any reasonable period" can be used; Tripodi specifically references 30 years. There have been a spate of news stories all saying 15 years, but this just doesn't appear to be supported.

I agree that there are costs to 401(k) loans, most particularly if the participant discontinues regular contributions in favor of repayment. I just wanted to correct at least one of the "facts" I see reproduced in the popular press, whcih almost always gets it wrong on retirement plans.

MikeInIndy of IN @ Jul 25, 2008 15:08:05 PM