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The 401k is a widely used retirement savings plan in the United States, and while most people know about the tax benefits of contributing to it, not many are aware of the tax benefits of borrowing from it. Borrowing from your 401k can be a useful financial tool, especially in times of need, and understanding the tax benefits of doing so can help you make an informed decision.
One of the main tax benefits of borrowing from your 401k is that the money you borrow is not subject to income tax. When you contribute to your 401k, you receive a tax deduction for the amount you contribute, and the borrowed amount is not considered income. This means that you do not have to pay income tax on the money you borrow, which can provide significant savings compared to taking out a loan from a traditional lender.
In addition to this, the interest you pay on the loan is paid back to your own 401k account. This means that you are essentially paying interest to yourself, rather than to a bank or other lending institution. While you will have to pay back the loan with interest, the interest payments go back into your own retirement savings, allowing you to potentially earn more on your investment over time.
Furthermore, borrowing from your 401k can also provide tax benefits when it comes to the repayment of the loan. The loan repayments are made with after-tax dollars, and when you eventually withdraw the money from your 401k in retirement, you will not have to pay taxes on the amount you borrowed and repaid. This can be a valuable tax benefit, especially if you expect to be in a lower tax bracket in retirement.
It’s important to note that while there are tax benefits to borrowing from your 401k, there are also potential drawbacks. If you are unable to repay the loan, you could face early withdrawal penalties and taxes, which could negate the tax benefits of borrowing from your 401k. Additionally, borrowing from your 401k could also impact the growth potential of your retirement savings if the borrowed amount is not able to earn a return while it is out of the account.
In conclusion, the tax benefits of borrowing from your 401k are often overlooked, but they can provide valuable savings and financial flexibility. Before deciding to borrow from your 401k, it’s important to consider all the potential implications and speak with a financial advisor to ensure that it is the right decision for your individual financial situation. If used wisely, borrowing from your 401k can provide a valuable source of funds with significant tax advantages.
Ya…. but that 9.25% goes back into YOUR account…..
Stocks are pretty unstable at the moment, but if you do the right math, you should be just fine. Bloomberg and other finance media have been recording cases of folks gaining over 250k just in a matter of weeks/couple months, so I think there are alot of wealth transfer in this downtime if you know where to look.
Eh…..
There are other benefits to borrowing from your 401k if you are near retirement with a stable job. We are all hearing talk of a recession around the corner. We don't know exactly that would mean to our 401k balances, but by taking a loan out you are taking money out the market and reducing market risk exposure and betting on yourself to pay back the loan. Then eith the payback of the loan what you are doing is basically dollar cost averaging back into your investments.
You pay tax as income when you make the loan, you pay it back with after tax money, you pay taxes on the total as an RMD. Sounds silly to me. What am I missing?
Thanks Josh! I was thinking that this wouldn't be a bad idea since the interest rates have gone up, and now that I'm closer to retirement and I've moved my investments into less risky funds that the upside for me was not likely to be 9 percent, but the downside (remembering 08) could be much worse!
Thanks!
I don't like doing this when it comes to investing in a regular brokerage account since you'll essentially be paying double taxes on the 401k money, once as you pay back the loan with post tax dollars and then again when you retire and start withdrawing.
Now what I like to do instead is takeout $6k, now $6500 and put all that loan money towards my yearly Roth IRA contribution and investing it in one lump sum. I got to fund my Roth with post tax money anyway, might as well use my 401k money which I can pay it back in a year.
Doesn't it cost $1,200 for the monthly loan payment ($1043 +15% income tax)? A 401K is payed back is after taxes. That tax would cost $157 x 60 months = a cost of $9,420 of taxes and then you pay taxes again when you pull it out..
worked for me. Paid off my mortgage with pre-crash dollars… lowered my interest rate and my payment, cut a decade off the mortgage, pay interest to myself and kept up with the contributions. What's not to love?
If this person in the example pulling the money out of 401K in 1 swoop would incur a 10% early withdrawal fee under age 59 1/2. plus taxes The borrowed portion would not incur a 10% penalty. You did mention this at the 13:45 time stamp of video.
During 1986 there was a one-time deal that if you had a 401K and had been employed at the company for 5 years you could pull it out penalty free and get a lower-than-normal tax rate on the money.
At that time, I barely qualified for all the conditions and emptied my $16,000 401K and used the money for a down payment on a $91,000 house. It turned out to have been a fantastic opportunity to buy a house for me and my family. Now as a retiree I am in a very secure financial position.
Just looking at the 401k loan by itself (not compared to a personal loan) you are paying taxes on the 401k loan twice correct? Paying tax once on loan repayment via employee payroll deduction (this is a after tax payment). Then paying tax a second time at 401k distribution time. Or am I mistaken?
I would not borrow from the 401k to invest outside of the 401k. I don't see the value for the hazzle. I also know people are more like to spend from a brokerage account then from an IRA or 401k. You don't want to make it easier to spend.
I did that several times. I borrowed from my 401k, paid my car loan in full, or used for high interest debt consolidation, and then paid myself back with interest. The payments seemed easier, and less of a burden, because they automatically came out of my paycheck. I never even knew I should consider tax ramifications.
thinking if borrowing from my 401k in the year I retire. im allowed only a 50k max and my job doesnt require all of it to be paid back when i retire. just ach debit every month
Why are you charging yourself interest ?
In your example you have the $50,000 from the loan proceeds earning interest at 5% but it doesn’t seem like you have considered where the $1043 per month is coming from and the foregone interest income on that money. Or alternatively have that $50,000 diminished by the monthly payments.
The way you are showing it you are just taking the same numbers and rearranging the formulas so the math would show it as a wash. However in reality you are most likely not going to have the same numbers to plug in to the rearranged formulas. From a purely retirement income standpoint you would need to factor in the difference in marginal rates between when you are working and when you are retired. If I am saving 22-24% now and taking it out later at 10-12% this makes a big difference. Take the same scenario but put the up-front tax savings in the 22-24% range into a taxable account and crunch the numbers using more realistic lower marginal rates post retirement and see what happens. Also, you forgot to add in that no longer making tax deductible contributions in the loan scenario would increase your taxes now, probably somewhere in that same $1877 range you are using in the no loan scenario.
It’s totally a wash Josh. You get $60+k out of the IRA by putting $60+k in.
Maybe in a pinch , but why not just contribute via roth . Unless you will need the money early I don't see the advantage personally. Still investing topic and video thanks
I like your creativity Josh❤
Can you fund a 401k and pay back your loan simultaneously? Would you end up missing an employer match for length of loan? Also this doesn’t make much sense if you’re funding a roth 401k?
I love the idea of paying myself the interest and earning interest on the borrowed and invested amount at the same time. I have also been thinking of a heloc for 100k at 6% and invest it at 8% and in 6 years my portfolio will be much better. It bothers me to have equity doing nothing. Or just put it in a CD at 5% and it is very little difference to convert my equity to investable dollars.
We did this to pay for our daughters wedding. Pulled the money out and repaid if over a few years and no harm no foul. Worked great and didn't even notice it gone.
The only tax benefit you gain that I see is that the amount of money you borrow from yourself from your 401k is tax free. (the 401k version of bank on yourself). Tax risk you did not talk about is if you loose your job, you have to pay back the loan immediately or that money becomes taxable income. That being said, I have borrowed money from my 401k and am paying it back now for about the next 5 years, then I will retire.
Thanks Josh ..! You are the man..!
Thank you, Josh. I have always felt this way (as long it was something you would have to take a loan for anyway). However, you are the FIRST financial advisor that I have heard support doing this.
When working I purchased all my vehicles with 401K loans. We were able to borrow and keep contributing to the 401K. I always felt it was better to pay myself the interest than pay it to the credit union. Only caveat about borrowing against the 401k is if you lose or quit your crappy old job you need to pay back the loan in full. So if you are secure in your position I don't see to much downside risk.
Josh, How come you never talk about self directed IRA's ? There are allot of things you can do with the "self directed IRA" that you can not do in a traditional IRA held at the standard brokerage account.
I dont remember what video it was but here it is
All of this presumes that you WILL remain with that employer for the entire 5 year period of the payback. Something you completely ignored is company matching dollars, and interest accrued on such, in the first scenario. The only way you borrow from your 401(k) account is if you can afford to make the resulting payment without reducing your contribution rate in any way. At the very least, you really need to contribute enough get the full match from your employer. My wife and I did take out 401(k) loans on two different occasions and we were very glad each time we paid those loans off. Never again.
so its kinda like a roth ,the money your paying back being already taxed?
can i borrow from ira the same way?
Hmmmm….. This might be a great way to purchase the side by side ATV that I have been wanting.
My Old Buddy Josh!!