Strategically taking a 401k loan and/or no-penalty withdrawal

[CT-Scott]

I'm not sure if this is the best subforum to post this to, but it seemed like this one made the most sense.

So, in case you haven't heard the latest news/rumors:

Congress may let you take $100,000 from your 401(k). What you should know
https://www.cnbc.com/2020/03/23/congres ... -401k.html

The short-version from that article is that they're considering allowing you to withdraw as much as $100,00 from your 401k penalty-free. You would still have to pay taxes, though. That's a big negative. But, they'll supposedly let you pay that tax back over the course of 3 years.

Additionally, they may increase the current $50,000 401k loan limit to $100,000.

More of the fine print indicates that this might only be available to someone who has COVID-19 or has been financially impacted (e.g., job loss) by COVID-19. Possibly also includes if your spouse falls into one of those categories? That first component is an interesting one, because if you believe it's as contagious as they claim, but that it also is *not* deadly for most people, then meeting the first criteria might not be too big of a stretch, and may not have too bad of a downside.

I don't want this thread to get too sidetracked into a COVID-19 discussion, though. The discussion that's more interesting to me is this:

If you feel strongly that the US economy is in for a long-term bag of hurt, does taking a 401k loan out make for a possibly good financial strategy? Same question goes for the penalty-free withdrawal scenario, though the answers for each of those may differ.

FWIW, I've never understood the common advice given that taking a loan from your 401k is always a horrible idea. But maybe I'm just being stupid and need to be better educated about it. My take has always been that if you were *really* in need of the money (e.g., you had a lot of high-interest credit card debt), that taking out a 401k loan to pay that off made perfect sense to me. Sure, you could try taking out some other type of low-interest loan, but you'll be paying that loan interest to someone else, whereas the 401k loan interest is paid back to you. And yes, you're paying that interest into a tax-deferred account, so you'll be paying tax on that interest someday, but that still doesn't sound like a good reason to give someone else your interest.

The other argument against it has always been that you're "missing out" on the gains those dollars would have enjoyed inside of your 401k. But that's where the present possible longer-term recession/depression scenario says, "hello!"

And in the case of my primary (employer-provided) 401k account, the current loan rate is 5.75%. So that's a guaranteed 5.75% rate of return for the duration of the loan.

Also, some side-benefits:
1) If I'm *not* at risk for losing my job *and* the economy turns around, I have the option to pay the loan back early.
2) If I *do* lose my job, I have the option to default on the remainder of the loan. And, again, if the 10% penalty is waived, that isn't as awful as it would have been before.

If nothing else, this will hopefully be an interesting topic for discussion and debate.

[sophie]

If it weren't for the double taxation, it would be kinda cool to pull $100K out of your 401K, invest it in the PP/GB, and then pay it back a year later having enjoyed some nice gains.

The double taxation though makes that not a good idea at all - unless your back is against the wall and your only other choice is a credit card at 20+% interest.

I've seen people argue both ways, but I don't get how it ISN'T double taxation. You take the money out of the account and pay tax on it, fair because you didn't pay tax on it going in. Then you pay the money back with after-tax money. Years in the future, you take the money out and lo and behold, it's taxed once again. The fact that the future taxes are probably a lower tax bracket and also the dollars will have been inflated in the meantime, doesn't make it better.

[InsuranceGuy]

[deleted]

[CT-Scott]

Right. As I indicated, there may be different answers for the loan vs withdrawal approach. But here's a new article I read this morning (opinion piece) where someone is recommending a "temporary tax holiday" for up to a $25,000 withdrawal:

Opinion: Workers need full access to 401(k) and IRA retirement savings now to combat coronavirus hit
https://www.marketwatch.com/story/worke ... =home-page

[sophie]

You take the money out of the account and pay tax on it, fair because you didn't pay tax on it going in.

For a loan you do not pay tax when you withdraw.

Ah right. That would be triple tax then.

You still pay the loan back with after tax money, correct? Or do you pay it back with pre-tax deductions? If the former, that's double taxation.

A tax holiday for a $25K withdrawal from a 401K would be awesome though.

[jhogue]

I would never take out a 401k loan because I always keep plenty of cash on hand.

All loans are leverage and leverage usually makes for bad investments, as Uncle Harry taught us.

[yankees60]

I would never take out a 401k loan because I always keep plenty of cash on hand.

All loans are leverage and leverage usually makes for bad investments, as Uncle Harry taught us.

I'd echo that. Except for some people they do not have the luxury of having plenty of cash on hand. Therefore, this may be one of their few means to their survival.

Vinny

[jhogue]

The OP was talking about a 401k loan as an investment, not as a means to survival.

As an investment, a 401k loan is always a bad idea. Tax laws are written to ensure that pulling money out of a 401k will cost you money. In the long run, you are always ahead to leave an investment inside of your 401k and simply let the retained earnings and dividends compound as long as possible.

As for using such a loan to pay off high interest credit card debt, I never met anyone who borrowed their way to personal financial wealth. Have you?

[CT-Scott]

As an investment, a 401k loan is always a bad idea. Tax laws are written to ensure that pulling money out of a 401k is a bad idea. In the long run, you are always ahead to leave an investment inside of your 401k and simply let the retained earnings compound as long as possible.

Right, but what if you felt strongly (yes, I know, a "feeling" can be wrong) that the market was going to suck for a long while and produce a much worse interest rate (perhaps even negative) than the 5.75% rate that you would be paying back into it?

Or, for that matter, what if you simply wanted to use it to pay off some other debt (home, auto, whatever)? Even low-interest home loans aren't as great as they were for many people, because of the recent tax changes (higher standard deduction).

[InsuranceGuy]

[deleted]

[CT-Scott]

I could be wrong but I believe that logic is flawed. Say I was going to buy a house and use 100k after tax for the down payment. Instead, I used a 401k loan so I avoided paying tax on the down payment. Paying back my 100k loan to my 401k after tax remedies this and I pay the tax on the loan payment instead of the down payment.

Right. This is where I'd like to use some investment spreadsheets I have to model different scenarios. I'll try to do that when I have some time and will post back.

The bigger issue with taking a loan right now is that you'll lock in any losses in your retirement accounts and miss out on the recovery.

Well, as I said in my last reply (right above yours), I'm of the personal opinion that things may get worse, or be a "bumpy flat", for a while. Speculation on my part, I know.

I haven't posted here the details of my story yet (but did link to a bogleheads thread in my introductory post where I have a lot of details), but we moved all of our 401k funds to Stable Value funds (or Money Market in some smaller accounts) on Thurs, 2/27, and moved all of our Roth IRA funds to MM on Mon, 3/2. And I'm still second-guessing not pulling the trigger to sell our Apple stock (was even thinking about doing it on today's "market up day"). Please don't get side-tracked with that, though...I promise I'll create a dedicated post so that you can all critique/congratulate me there.

I did want this thread to be more of a generic discussion, but I will add that part of my reasoning for now wanting to hoard cash is that we'd like to move (downsize), and we'd like to have the flexibility to move on a new house before needing to have our current house sold. The current house hunting/buying/selling situation in this "locked down" coronavirus world today is complicating that, but could work out favorably later this year as a buyer (e.g., more inventory, low rates), though probably not so great as a seller.

[CT-Scott]

I don't get this. Does the 5.75% get credited to YOUR account or does that go to the 401k admin? And even if it goes into your own account, you still have to get the money to pay that back from somewhere. If you get it from a taxable account, you have to pay taxes on it. Why not leave the money in the 401k and defer the taxes until you withdraw. You can invest in the same thing and earn the same return (if you have a full brokerage window).

The 5.75% goes back into *my* account, and there are no taxes on a 401k loan.

[CT-Scott]

But there is still tax on the appreciated assets that you use to refund the 401k.

Gotcha, right. I think there was some confusion before about whether 401k loans were taxed. Even so, I'd like to run some comparisons assuming a possible low return on interest inside my 401k.

[yankees60]

The OP was talking about a 401k loan as an investment, not as a means to survival.

As an investment, a 401k loan is always a bad idea. Tax laws are written to ensure that pulling money out of a 401k will cost you money. In the long run, you are always ahead to leave an investment inside of your 401k and simply let the retained earnings and dividends compound as long as possible.

As for using such a loan to pay off high interest credit card debt, I never met anyone who borrowed their way to personal financial wealth. Have you?

I'm generally Mr. Anti-Debt! On all levels! Only for a business where it is definitely being used to purchase a highly productive asset.

[CT-Scott]

So, I think this is the latest info on the 401k loan/withdrawal-related changes that are in the stimulus bill:
https://www.cnbc.com/2020/03/25/what-th ... ement.html

I'm not sure if there's still a chance that some of this will get removed or changed during the debate today. If not, per that article, it sounds like it will be:

• This year, you’ll be able to take a coronavirus-related distribution of up to $100,000 from your retirement plan or IRA without the 10% early withdrawal penalty, according to the most recent version of the bill.

• The bill also relaxes the rules around retirement-plan loans, allowing you to borrow up to $100,000 from your 401(k). That’s double the amount you can normally take.

• Retirees who would normally take required minimum distributions from their retirement savings can waive them for 2020.

So, if you take a withdrawal, you won't get hit with the 10% penalty, but you'll still have to pay taxes.

Also, it's not clear as to what sort of "evidence" you would need to show to prove that it's coronavirus-related. I would think that the HIPAA laws might complicate that, so I wouldn't be surprised if they just "take your word for it," but we'll see.

I'm less interested in the withdrawal aspect, given the added tax-hit. But I could be tempted by the loan.

[CT-Scott]

I actually didn't read that last article I linked to, but here's another one that I did read:

Coronavirus stimulus-package tax relief: Withdraw $100K from your IRA — and repay in 3 years with zero tax liability
https://www.marketwatch.com/story/coron ... =home-page

So, it sounds like you'll have 3 years to pay the income tax, and it sounds like you could just wait till the 3rd year to pay it all? Because it sounds like you also have the option to pay the entire distribution back within 3 years. Which, if you do, you won't have to pay taxes on it at all? So then it becomes a 0% 3-year loan? Maybe I'm still a little confused.

The article points out the various "qualifications" including a couple which are vague and will get further guidance from the IRS later. But, as I stated previously, I'm personally curious as to whether they'll really require *anyone* to provide evidence, seeing as this is a medical-related thing, and I would think that HIPAA laws would protect someone from needing to reveal medical details. But maybe not.

[CT-Scott]

Well, now I'm just talking to myself but...

I did some more Googling. One of the existing qualifications for taking a "Hardship Withdrawal" from your 401k is already medically-related. And based on additional Googling, it sounds like HIPAA doesn't necessarily shield you from having to provide more specific evidence to your plan (or Employer?) in order to qualify for the withdrawal. So, it sounds like in order to take advantage of this opportunity, you may need to show evidence (including medical-related evidence) that you (or your spouse or child) have been affected directly by COVID-19.

There's still a possibility that some plans may relax requesting that info. And it's still a possibility that simply showing evidence that you (or spouse or child) contracted COVID-19 may be "all you need" and you may not need to tie it directly to a financial hardship? Again, still a lot of uncertainty here. Will have to wait for more details to emerge.

[CT-Scott]

Here's another article which adds a couple of interesting (unverified) tidbits:

401k withdrawal penalties would be waived under coronavirus stimulus package
https://fortune.com/2020/03/27/401k-wit ... lief-bill/

Notable quotes (emphasis added by me):

The legislation requires that the money be a “coronavirus-related distribution,” but the rules are loose. People diagnosed with the virus are eligible, along with anyone who “experiences adverse financial consequences” as a result of the pandemic, including an inability to find work or child care. Retirement plan sponsors are told to rely on employees’ word that they’re eligible.

The bill also makes it easier to borrow money from 401(k) accounts, raising the limit to $100,000 from $50,000. The payment dates for any loans due the rest of 2020 would be extended for a year.

[foglifter]

But there is still tax on the appreciated assets that you use to refund the 401k.

Gotcha, right. I think there was some confusion before about whether 401k loans were taxed. Even so, I'd like to run some comparisons assuming a possible low return on interest inside my 401k.

Double taxation does happen, but it only applies to the interest, not the principal. When you take a loan you're getting your pre-tax money, use it as post-tax money (you're not paying tax on it) and then you return it back. But the interest you pay is post-tax money (you paid taxes on it already), so when it's returned back to the account it "blends" with the rest of the account and will be taxed in the future when you start withdrawing from your 401k.

BTW there is no double taxation at all for Roth 401k accounts.

[CT-Scott]

Let me give a simple example and open it up for discussion:

Let's say I have $150,000+ in the bank and I want to buy a $200,000. There are many ways to slice and dice this, but let's say I have an interest in paying off as much as the mortgage as possible, up front. Here are two possibilities:

1) I pay $100K cash, and then finance the other $100,000 over 10 years @ 3%.
2) I pay $100K cash, and then take a loan out of my 401k for the other $100K over 10 years @ 5.5% (payable to my 401k).

Which approach is better, and why?

[yankees60]

Let me give a simple example and open it up for discussion:

Let's say I have $150,000+ in the bank and I want to buy a $200,000. There are many ways to slice and dice this, but let's say I have an interest in paying off as much as the mortgage as possible, up front. Here are two possibilities:

1) I pay $100K cash, and then finance the other $100,000 over 10 years @ 3%.
2) I pay $100K cash, and then take a loan out of my 401k for the other $100K over 10 years @ 5.5% (payable to my 401k).

Which approach is better, and why?

Let's assume no inflation and, therefore, those rates are both nominal and real rates. Not realistic but this is complicated enough so some simplifying assumptions are necessary.

1) Over ten years you've have out paid a total of $117,231 on the morgage. But I have to also assume you can only earn (safely) 3% at best. So your $50,000 earning 3% each year turns into $67,196 after ten years.

Therefore after 10 years you own a house worth $200,000 (remember no kinds of inflation) at a net cost of $217,231. You have now have assets of $267,186 at a cost of $217,231. That's an increase of $49,955 in your net assets. I'm also assuming you get no tax benefit from your interest payments since it's so tiny in relation to the standard deduction for a married person such as yourself.

2) You turn that same $50,000 into $67,196. This is now turning into somewhat of a trick question. No matter what rate you are paying to your 401(k) it's a wash. On the one hand you are earning this good rate of 5 1/2% but on the other it is all being financed by you from another pocket. Therefore, you net nothing on this.

What is missing is the rate that you'd be getting in your 401(k) if you didn't borrow and repay into it. And, then doesn't that simply come down to if that rate is greater than or less than 3% mortgage offer you have?

If you earning more than 3% in the 401(k) then it'd make sense to keep the money in the 401(k) and borrow. If you were only earning 1% in the 401(k) then it would not make sense to borrow at 3% but instead to use the borrowed money from the 401(k).

I did all the calculations in 1) assuming I could do something similar for 2) but not enough detail is provided for 2) (mainly the 401(k)'s projected earning rate) to make a direct comparison to which would provide the greater net assets at the end of the ten years.

And, I dutifully tried to avoid any tax considerations.

Vinny

[mathjak107]

If it weren't for the double taxation, it would be kinda cool to pull $100K out of your 401K, invest it in the PP/GB, and then pay it back a year later having enjoyed some nice gains.

The double taxation though makes that not a good idea at all - unless your back is against the wall and your only other choice is a credit card at 20+% interest.

I've seen people argue both ways, but I don't get how it ISN'T double taxation. You take the money out of the account and pay tax on it, fair because you didn't pay tax on it going in. Then you pay the money back with after-tax money. Years in the future, you take the money out and lo and behold, it's taxed once again. The fact that the future taxes are probably a lower tax bracket and also the dollars will have been inflated in the meantime, doesn't make it better.

this is certainly not true in a traditional .

it is not double taxed .... only any interest you paid is double taxed .

just imagine you borrow 100k out ... . it was never taxed ... so you have 100k in untaxed money in your hand ... ...when you put it back either immediately or down the road , it is no different than taking 100k out as a loan and deciding ooops don't need it after all, and you put it back in ... you are REPLACING THE 100K OF UNTAXED MONEY IN EFFECT . ....

you could twist things a bit and say that the money you put back was money that was taxed from your pay check .

if you say it was money taxed from your pay check you put back, then it is washed out with the 100k untaxed money that you pulled out that has now been paid back and you are keeping tax free ..... in either case it is washed out ....you only get taxed once down the road.

however any interest you pay on that loan will get taxed 2x but never the loan amount .... this is suzie ormann nonsense she used to say .

[CT-Scott]

Here's a new article on this:

New Stimulus Bill Unlocks IRA and 401(k) Dollars for Financially Affected
https://www.entrepreneur.com/article/348352

Notable quote:

Who Can Take the Penalty-Free Distribution?

The distribution rules are personal to the account owner and include anyone who has experienced “adverse financial consequences” from the pandemic. This is a broad definition and one that the account owner claims with their account administrator. Adverse financial consequences include being subject to a quarantine, being furloughed or laid off, having your business closed or hours reduced or being unable to work due to childcare changes and availability (closed schools, closed childcare facilities). The rule also includes anyone who has been diagnosed with COVID-19 or whose spouse or dependent is diagnosed with the virus.

What constitutes a "quarantine"? Forced "stay at home" requirements by a state could potentially be considered a quarantine. Feeling like you have symptoms and having a doctor advise you to self-quarantine would surely qualify, no? Would you need some sort of "evidence" to provide to your plan administrator? I'll continue to monitor this.

Edit: The 401k account I have through my employer is with Fidelity. They have a notice on their "loan/withdrawal" page indicating that they are working on this and advises to "Please check back here for future updates."

[Xan]

Why would I want to take money out of my IRA? Isn't the point to put money into it? I mean, yes, if I need it to live on, which is what this is for. It doesn't seem like a useful tool otherwise.

[mathjak107]

I agree ...that is the last place I would touch