Can you come out ahead taking a 401k loan in a down market

[SeductivePig]

Basically I want to take out a 401k loan to pay off some debt, since right now I'm seeing no returns at this point. It fluctuates between -1 and +2%.

My thought is that the interest I'm paying is to myself, so I would potentially be coming out ahead on this move - I'd pay off the balance within the year, it's a small loan ($10-12k) that I want.

If I do this, would I still be able to contribute to the 401k while paying back my loan?

 

[Exterous]

Basically I want to take out a 401k loan to pay off some debt, since right now I'm seeing no returns at this point. It fluctuates between -1 and +2%.

My thought is that the interest I'm paying is to myself, so I would potentially be coming out ahead on this move - I'd pay off the balance within the year, it's a small loan ($10-12k) that I want.

Is it possible? Yes. Likely? Depends on your interest rate on the debt and how lucky you are

If I do this, would I still be able to contribute to the 401k while paying back my loan?

Depends on your 401k plan but highly unlikely. Another thing to consider is that many require immediate repayment if you leave your job for any reason or are fired.

 

[IronWing]

My 401K allowed me to contribute at the max rate while also paying back a loan. In my case, the strategy you've described worked very well as the money I borrowed skipped out on much of the market carnage in 2008-9 (not so much for the rest of my 401K ). However, as Exterous stated, there is significant risk, both market risk and job loss risk.

 

[SeductivePig]

My 401K allowed me to contribute at the max rate while also paying back a loan. In my case, the strategy you've described worked very well as the money I borrowed skipped out on much of the market carnage in 2008-9 (not so much for the rest of my 401K ). However, as Exterous stated, there is significant risk, both market risk and job loss risk.

My debt is 0% interest, I just want to get rid of it because it's been nagging at me a long time. The only reason I'm considering this option is because of the current return on my 401k portfolio and the fact that I could possibly come out ahead since the loan balance is relatively small ($10-12k) and the interest I pay back to myself may end up exceeding the marginal returns I've been seeing this year.

 

[Blackjack200]

OP, what are you invested in? The S&P 500 has had positive returns every year for about a decade now. There is no way in hell your performance should be sideways.

Depends on your 401k plan but highly unlikely.

That is absolutely wrong. I've never even heard of a 401(k) plan that prohibits new contributions from participants with outstanding loans.

 

[Viper GTS]

I don't think I'd do it for something at 0%.

The spread between paying someone else 10-15% and paying yourself 4% or whatever makes it far more justifiable.

The only way you'd come out dramatically ahead on a 0% loan is if the market tanks after you pull the money out and then you get to buy back in at much lower prices. But timing that is far easier said than done.

That is absolutely wrong. I've never even heard of a 401(k) plan that prohibits new contributions from participants with outstanding loans.

Hardship withdrawals frequently come with those kinds of restrictions (time windows, because obviously they aren't being repaid, but still). I have never seen that for a loan.

Viper GTS

 

[Thebobo]

Basically I want to take out a 401k loan to pay off some debt, since right now I'm seeing no returns at this point. It fluctuates between -1 and +2%.

My thought is that the interest I'm paying is to myself, so I would potentially be coming out ahead on this move - I'd pay off the balance within the year, it's a small loan ($10-12k) that I want.

If I do this, would I still be able to contribute to the 401k while paying back my loan?

Guess it depends on your plan? But I did just that recently to pay some medical bills.

 

[deadlyapp]

Better to do this as the market is coming down, rather than if the market is already at the bottom.

With that said, if you're paying off 0% interest debt, I would skip it as you've got even less benefit to doing this. If you had high APR loans that gave additional benefit above and beyond the market benefits (which are very volatile) then I'd say go for it.

Personally I took out a 20k 401k loan at the end of last year to pay off a vehicle and some other outstanding balances in anticipating of selling the vehicle and some other incoming money. I just paid the loan back off but haven't checked to see if I got any benefit from doing it (other than the tangible benefit of being able to sell the vehicle free and clear, improving my credit marginally enough to get a better rate on another vehicle, etc)

 

[Exterous]

OP, what are you invested in? The S&P 500 has had positive returns every year for about a decade now. There is no way in hell your performance should be sideways.

Its only up ~3% YTD and has been negative at times for the year to date metrics
https://www.marketwatch.com/story/sp-500-turns-negative-for-2018-2018-04-20

That is absolutely wrong. I've never even heard of a 401(k) plan that prohibits new contributions from participants with outstanding loans.

Oh so you never heard of it so it must not be a thing.

If you borrow money from your 401(k) plan, most plans have a provision that prohibits you from making additional contributions until the loan balance is repaid.

https://www.investopedia.com/articles/retirement/06/eightreasons401k.asp

Some 401(k) plans do not allow you to contribute to the plan while you are making loan repayments.

https://www.thebalance.com/facts-about-401k-loans-2388811

I've participated in (3) 401k plans that prohibited contributions if you had a loan outstanding (and aside from just a hardship situation)

 

[Blackjack200]

I've participated in (3) 401k plans that prohibited contributions if you had a loan outstanding (and aside from just a hardship situation)

Who were the administrators? The only reason I can even come up with for a provision like that is if the recordkeeper is not sophisticated enough to process new contributions and loan repayments at the same time.

 

[SeductivePig]

OP, what are you invested in? The S&P 500 has had positive returns every year for about a decade now. There is no way in hell your performance should be sideways.



That is absolutely wrong. I've never even heard of a 401(k) plan that prohibits new contributions from participants with outstanding loans.

I am diversified into small/mid/large cap Vanguard.. lowest fees AFAIK, and last year I had a yearly return of 25%. This year it's been essentially 0.

 

[Exterous]

Who were the administrators? The only reason I can even come up with for a provision like that is if the recordkeeper is not sophisticated enough to process new contributions and loan repayments at the same time.

T. Rowe Price, Fidelity and a local Financial Planning group (Fidelity was the longest ago). My understanding is that this is an employer electable option for the large players while the small players have complex fee structures where disallowing certain options or charging fees for specific, less common actions directly to employees will lower the company's fees

 

[Blackjack200]

I am diversified into small/mid/large cap Vanguard.. lowest fees AFAIK, and last year I had a yearly return of 25%. This year it's been essentially 0.

So when you say "I'm seeing no returns at this point", you're literally referring to a four and a half month period of time?

Okay, I'm not going to tell you how to think. Those are generally excellent funds with low expenses, and it wasn't too long ago that very few k plan participants had access to Vanguard at all, but if you want to take out a loan to pay back your debt, you should ask your plan's administrator if you can continue to contribute. I've never heard of a plan that prohibits this, but others in this thread have, so we can't give you a general answer, it's specific to your plan.

 

[Blackjack200]

T. Rowe Price, Fidelity and a local Financial Planning group (Fidelity was the longest ago). My understanding is that this is an employer electable option for the large players while the small players have complex fee structures where disallowing certain options or charging fees for specific, less common actions directly to employees will lower the company's fees

Right, I don't doubt you, I just can't understand why an employer would elect that unless there was fee impact. For a provider as large as T. Rowe or Fidelity I doubt they would charge a fee for that feature.

I would think that allowing new contributions to participants with outstanding loans would help with plan testing. The only other thing that I can think of is if the DoL changed the regulation to allow it, so it's sort of a vestigial thing for older plans or plan administrators.

 

[deadlyapp]

T. Rowe Price, Fidelity and a local Financial Planning group (Fidelity was the longest ago). My understanding is that this is an employer electable option for the large players while the small players have complex fee structures where disallowing certain options or charging fees for specific, less common actions directly to employees will lower the company's fees

Yep I think you're right.

My employer allowed contributions while a loan was outstanding, however they would not let you pay off the loan balance above and beyond the normal bi-weekly repayment, unless you were going to pay the loan off in full. Kind of annoying but prevents a lot of additional transactions.

Edit: we also use T Rowe Price

 

[Blackjack200]

Yep I think you're right.

My employer allowed contributions while a loan was outstanding, however they would not let you pay off the loan balance above and beyond the normal bi-weekly repayment, unless you were going to pay the loan off in full. Kind of annoying but prevents a lot of additional transactions.

Edit: we also use T Rowe Price

Yes, my plan has that provision too. I took a loan out 6 years ago and I was not allowed to make extra principal payments unless it was for the entire amount outstanding.

 

[dullard]

Basically I want to take out a 401k loan to pay off some debt, since right now I'm seeing no returns at this point. It fluctuates between -1 and +2%.

My thought is that the interest I'm paying is to myself, so I would potentially be coming out ahead on this move - I'd pay off the balance within the year, it's a small loan ($10-12k) that I want.

If I do this, would I still be able to contribute to the 401k while paying back my loan?

I think you are mixing two questions here.
1) Should you pay off your 0% loan with a different loan.
2) Should you be invested in the market at this point in time.

The answer to #1 is clearly a no. The answer to #2 is yes. But if you really wanted to get out, then many 401Ks have a cash or cash-like option.

 

[PowerEngineer]

Assuming that you do not have sufficient cash flow to just start paying down that debt and that you are currently contributing some money into your 401k, you might consider reducing your 401k contribution and use the added cash flow to pay down that debt. I know this would have a tax consequence but still might be better than taking out a 401k loan. Just a thought...

 

[s0me0nesmind1]

Assuming that you do not have sufficient cash flow to just start paying down that debt and that you are currently contributing some money into your 401k, you might consider reducing your 401k contribution and use the added cash flow to pay down that debt. I know this would have a tax consequence but still might be better than taking out a 401k loan. Just a thought...

As a tax consultant I can never recommend that if you are maxing out every year But it's doubtful OP is maxing out his 401k each year, let alone maxing out a ROTH IRA on top of it.

But that said, debt is something you shouldn't really be getting into unless it's healthy debt like a low-interest mortgage. Hell, I took out a car loan on our last used vehicle purchase simply because the auto-maker was giving 0.9% interest... My fucking savings account gives me 1.5%, so it would be essentially have been a loss to NOT take the loan.

Either way, I don't predict a market downturn anytime soon, so I wouldn't expect a 401k loan to "pay-off" - buuuut. if you are in financial trouble, and you do have a safe job that isn't about to fire/lay you off, then it might be the best call. That's up to you to determine OP.

 

[IronWing]

As a tax consultant I can never recommend that if you are maxing out every year But it's doubtful OP is maxing out his 401k each year, let alone maxing out a ROTH IRA on top of it.

If one maxes out a traditional 401k and catch-up (18,500 + 6000), what is the limit on IRA contributions, either traditional or ROTH?

 

[s0me0nesmind1]

If one maxes out a traditional 401k and catch-up (18,500 + 6000), what is the limit on IRA contributions, either traditional or ROTH?

$5500 at the moment (not including catch-up - which is an additional $1000).

However, if you are maxing out a 401k, it isn't likely you can contribute to a traditional with the income limitations (unless you are married and your wife doesn't work). Hence, you would probably have to go with the ROTH - Which isn't a problem - either way it is most definitely tax advantage and well worth it regardless of traditional or ROTH.

To put that into perspective, currently I max out 2x 401ks, and 2x IRAs. Below is the math:
$37,000 - ($18,500 *2 for my + wife's 401)
$11,000 - ($5,500 *2 for my + wife's ROTH IRA)
=$48,000 / year.

Oh also I max out an HSA for an additional $6,900 in retirement, bringing the total to $54,900 in tax advantage accounts


See: https://www.fidelity.com/retirement-ira/contribution-limits-deadlines for IRA income limitations.

 

[Exterous]

$5500 at the moment (not including catch-up - which is an additional $1000).

However, if you are maxing out a 401k, it isn't likely you can contribute to a traditional with the income limitations (unless you are married and your wife doesn't work).

Given that you could have a joint salary income of up to $258,000 and still be eligible for a full IRA contribution in the right situations (maxed 40Xy + 457)*2 or $222,000 in a more likely situation that should leave plenty of room for an IRA

 

[nOOky]

OP I would just stop my 401k contributions and hammer away at the loan and pay it off quickly if you must. I'm not sure what percent you are putting into your 401k, but don't forget the reduced tax burden the 401k gets you on your lowered gross wages, or if your employer matches. A 0% loan is a much better burden than paying back a 401k loan, especially if your plan doesn't let you put money back in right away. I'd be surprised if you could even borrow the money for that purpose anyway, your saving for retirement, not to pay off loans.

 

[IronWing]

Thanks, I found this explanation here:

https://www.irs.gov/retirement-plan...-you-are-covered-by-a-retirement-plan-at-work

 

[dank69]

I can't imagine it ever makes sense to pay off 0% debt. Pay it off as slowly as possible and invest extra cash in something that earns interest.