Borrowing from crappy 401k to invest in PP

[MediumTex]

Let's say you have a $200,000 account balance in your 401(k) plan.  You could borrow $50,000 and buy gold with it and then gradually repay the loan over the next 5 years. 

You would need to have the ability to make the loan payments, but in a pinch it could be part of a cobbled together PP.

[MikeK]

How exactly will borrowing help?

I'm certainly no expert, but AdamA suggested that to me as well.  Best I could come up with was it would make all the funds immediately available and you'd just buy other positions within your 401k as you paid back the loan.

I'll also wait for the 'real' answer

mike

[foglifter]

I have a recent experience (June 2011) of taking a loan from my 401(k). Unless your 401(k) has different rules here's how it works:
- you can only borrow up to 50% of your account balance with the maximum of $50K. So you can't get the whole 50K you have in your account now, you will get only 25K.
- the interest rate is prime+1%, for me it was 4.25%. The good thing is you're paying it back to yourself.
- you go online into your 401(k) account, do a few clicks and your loan process is started!
- the plan provider will sell certain amount from each of your positions prorated according to %% from the total balance. So if you have 50/50 stock/cash they will liquidate 50% of your stock position and 50% of your cash position.
- you will get a check.
- the loan works like installment loan: a fixed amount is taken post-tax from your paycheck and contributed into your 401(k) according to the investment choices you have set.
- note that the account balance of your account won't drop - it will just show that loan as a separate position, which will be slowly dropping with each repayment.
- IMPORTANT: if you leave your employer you will have to repay the loan in 30 days.

[MediumTex]

- IMPORTANT: if you leave your employer you will have to repay the loan in 30 days.

Although this is the rule with most plans, it is not a requirement.

Some employers permit you to continue making payments after you have terminated.  You just get a payment book in the mail.

[foglifter]

- IMPORTANT: if you leave your employer you will have to repay the loan in 30 days.

Although this is the rule with most plans, it is not a requirement.

Some employers permit you to continue making payments after you have terminated.  You just get a payment book in the mail.

Good to know, thanks for a tip.

[MediumTex]

- IMPORTANT: if you leave your employer you will have to repay the loan in 30 days.

Although this is the rule with most plans, it is not a requirement.

Some employers permit you to continue making payments after you have terminated.  You just get a payment book in the mail.

Good to know, thanks for a tip.

I once left a job and scraped together the funds to  pay off an outstanding 401(k) loan.  Literally, the day after I put the check in the mail I received the payment booklet to continue paying on the loan.

Doh!

[moda0306]

Wait... you stay invested fully with the $100k?  This is like investing on margin isn't it?  I would think that if you pull out the $50k in loan, you only have $50k left in the 401(k) to invest...  You're borrowing it from yourself, not the broker.

[moda0306]

But the interest goes to you, not the brokerage firm?

This doesn't make sense...

[MediumTex]

When you take a $50,000 loan from a $100,000 401(k) plan account, it will leave a balance that can be invested in the 401(k) account of $50,000.

[AdamA]

I'm certainly no expert, but AdamA suggested that to me as well.  Best I could come up with was it would make all the funds immediately available and you'd just buy other positions within your 401k as you paid back the loan.

I'll also wait for the 'real' answer

mike

I'm no expert either! 

My answer (not necessarily the 'right' answer) is that if you borrow from your 401K, you can use the money to buy assets that aren't available within the 401K.  So if you have $100K in your 401K, which offers only say, a cash fund and a stock fund, you could borrow $50K and buy LTT's and gold outside of the 401K.

You'd have only $50K in your 401K, and you'd have to pay it back to yourself in a fixed amount of time (usually between 2 and 5 years, I think).  You DO NOT get tax deductions based on the money you're paying back into the 401K (obviously). 

So if you're going to do it you'd want to make sure that you would be capable of paying yourself back each month. 

[AdamA]

When you take a $50,000 loan from a $100,000 401(k) plan account, it will leave a balance that can be invested in the 401(k) account of $50,000.

I can vouch for that.

[foglifter]

When you take a $50,000 loan from a $100,000 401(k) plan account, it will leave a balance that can be invested in the 401(k) account of $50,000.

I can vouch for that.

I guess I misinterpreted foglifter's comment.

Sorry if I misled you. I know it's confusing, but that's how it is: with every loan payment the loan position will go down for the amount of principal in the payment, and the other positions in the account will go up for the amount of principal+interest. If you are also contributing to your 401(k) the contributions will show up as separate transactions.

The interest is paid to you, not the brokerage. You pay yourself back with post-tax money, but then the interest you paid will grow tax-deferred along with the rest of the money in the account.

Also I forgot to mention the loan fee: I believe it's something round $50 a year.

[KSActuary]

Probably the biggest problem with borrowing from your 401(k), outside of the obvious as discussed before, is that you are repaying your loan with after-tax money. This means that you are replacing pre-tax dollars with after-tax dollars in the account but you will be taxed again at your marginal rates when you withdrawal the money at retirement.  In other words, double taxation.

[foglifter]

Probably the biggest problem with borrowing from your 401(k), outside of the obvious as discussed before, is that you are repaying your loan with after-tax money. This means that you are replacing pre-tax dollars with after-tax dollars in the account but you will be taxed again at your marginal rates when you withdrawal the money at retirement.  In other words, double taxation.

Well, not exactly. You end up paying double tax only on the interest, not the principal. There are lots of articles on the topic on the Web, just google "401k loan double taxation myth", here's just one example:

http://www.vanguardblog.com/2009.07.24/ ... twice.html

[KSActuary]

I understand his argument. I cannot control what plan participants do with their loan withdrawals. All I know for sure is that the account now holds money that was already taxed and now will be taxed again. In my opinion, not a very effective tool for retirement planning but withdrawing any money from a 401(k) via a loan is not a great retirement planning approach. Distributions from 401(k)s for emergencies should be handled through the hardship provision.

[MediumTex]

I understand his argument. I cannot control what plan participants do with their loan withdrawals. All I know for sure is that the account now holds money that was already taxed and now will be taxed again. In my opinion, not a very effective tool for retirement planning but withdrawing any money from a 401(k) via a loan is not a great retirement planning approach. Distributions from 401(k)s for emergencies should be handled through the hardship provision.

It sounds like you are a retirement plan professional.  If so, you know that the whole concept of the 401(k) plan design is based upon some pretty absurd assumptions.

The 401(k) plan design assumes the following:

1. Employers are going to be able to put together an appropriate investment lineup when the investment providers have a strong incentive to make their offerings very stock-heavy.

2. Employers are going to be able to offer a defined contribution plan with employer contribution rates and other plan design features that actually might allow a person to fund a retirement benefit when those same employers have shown that they do not have the ability to manage the risk of a traditional defined benefit plan very effectively.  In other words, if the employer hasn't shown the ability to manage assets, market volatility and contribution rates effectively with respect to their defined benefit plans, what makes them think that their vastly less sophisticated rank and file employees are going to be able to do any better?

3. The average employee is going to be able to save enough money to fund a retirement income.

4. Assuming that the employee does somehow save enough money to fund a retirement income, he is also going to be able to make the correct investment decisions over a 30-40 year period to keep the market from gobbling up a lot of his savings.

5. Assuming that the employee saves enough and invests it skillfully over several decades (you only have to screw up once in an entire career to dramatically reduce the retirement income that will be available to you), the employee will be able to take a lump sum amount and convert it into a stream of income that will provide retirement income that the employee won't outlive.

Putting #1 and #2 aside, most employees don't even do #3, never mind #4 and #5.

I was talking with a fund provider once about their target date funds, and I was basically saying that they ought not be out there selling fairy tales in the form of mutual funds.  Rather than defending their funds (which is what salesmen normally do, even when they are selling garbage), the guy just came out and said that if they attached more realistic return projections to their funds it would be clear to employers and employees that no one would ever be able to retire using a 401(k) plan and it would sink their retirement plan business.  I thought this was a sort of shocking admission, even though it is a truth that has always been self-evident to me; I just never thought that anyone would actually own up to it.

In my work I get to see lots of 401(k) plan data for many different employers and the number of account balances that would actually fund a decent retirement (which for most people would be an account balance of $500,000-$1,000,000 at a minimum) is TINY. 

Ironically, and there was an interesting story in the media the other day about this, many of the people who DO have 401(k) account balances large enough to fund a decent retirement have been heavily invested in company stock that happens to have done much better than the overall market.  An observant person will immediately see that this sort of thing is more like winning the lottery than an effective retirement saving strategy. 

In many ways, the whole idea of a 401(k) plan is based on a fantasy.  What is unfortunate (and in my view actually a little cruel) is that so many hardworking people have been convinced that this fantasy is a reality and they won't find out the truth until it is way too late to do anything about it.

[stone]

Aren't they just supposed to be a way to create a pool of "dumb money" that will provide buy-high-sell-low losses to feed into the finance industry who pay for the political campaign funds?

[MediumTex]

Aren't they just supposed to be a way to create a pool of "dumb money" that will provide buy-high-sell-low losses to feed into the finance industry who pay for the political campaign funds?

Yes.

But few people fully grasp this fact.

Back when George W. Bush was proposing individual accounts to replace Social Security benefit accruals, I wondered if he was just that dumb that he thought this would actually work, or if he was actually very smart and was simply serving his constituents in the financial services industry, and he just thought the rest of us were that dumb.

[amp]

In my work I get to see lots of 401(k) plan data for many different employers and the number of account balances that would actually fund a decent retirement (which for most people would be an account balance of $500,000-$1,000,000 at a minimum) is TINY. 

MT,

This is good stuff, always learn from this site.  Honestly, despite contributing to various plans over the past 20 years, I've never thought too deeply about 401Ks.  I just see them as a tax advantaged way of saving, haven't considered the ulterior motives.

I'd assume that part of the reason you'd see the relatively low 401k balances is because not everyone stays with the same company for a really long time.  If you were to look at my company's 401k plan you'd see about 1/3 of my total 401k contributions and earnings as I've changed employers and 2/3rds is now in a Traditional IRA (which I could roll into my current 401K, but the investment choices are lacking... surprise!).

Also, I'm trying to understand all of the hate (here and other places) of 401Ks.  Sure, they aren't perfect and it seems most lack a broadly diversified menu of investments (assumption #1 below).  Other than that, what's the problem?

Defined benefit plans have obvious issues as you pointed out in assumption #2.  Don't want to rely on my directors and eventually the PBGC to determine my retirement check.

Assumption #3... are you saying the contribution limit should be raised (I'd agree with that) or that employees can't afford to contribute enough to fund their retirement?  I'd disagree with that last part, they'd just have to shift their consumption expectations, which seem to be way out of whack.  Yes, there are absolutely some people who can't afford to contribute, but I don't see that as a problem with the 401K.

#4... isn't that be the case whether one uses a 401k or not?  I really don't see that issue as being distinct to 401Ks in any way... same for assumption #5.


But let's assume that, for all the assumptions you've listed, 401Ks are fatal. 

Would you suggest one just saves outside of a 401K and pays the taxes on contributions now and earnings along the way or are you leaning more towards corporate and/or government control of retirement? 

In other words, without regard to the current systems in place and working from a completely blank slate, how do you think our retirements should be funded?

Thanks,
amp

[moda0306]

MT,

Aren't we forgetting about Social Security here?  It seems to me if a couple has their home paid off and pulls in about $30k per year in Social Security (not unreasonable)... then less than $500k in retirement savings should be ok if their frugal and properly insured. 

[MediumTex]

In my work I get to see lots of 401(k) plan data for many different employers and the number of account balances that would actually fund a decent retirement (which for most people would be an account balance of $500,000-$1,000,000 at a minimum) is TINY.  

MT,

This is good stuff, always learn from this site.  Honestly, despite contributing to various plans over the past 20 years, I've never thought too deeply about 401Ks.  I just see them as a tax advantaged way of saving, haven't considered the ulterior motives.

I'd assume that part of the reason you'd see the relatively low 401k balances is because not everyone stays with the same company for a really long time.  If you were to look at my company's 401k plan you'd see about 1/3 of my total 401k contributions and earnings as I've changed employers and 2/3rds is now in a Traditional IRA (which I could roll into my current 401K, but the investment choices are lacking... surprise!).

Sorry, I should have clarified that I was talking about situations where it was clear that an employee had spent most of his/her career at the same employer.  When you look at the date of hire and date of birth you can get a sense of what the balance ought to be.

Also, I'm trying to understand all of the hate (here and other places) of 401Ks.  Sure, they aren't perfect and it seems most lack a broadly diversified menu of investments (assumption #1 below).  Other than that, what's the problem?

I don't have any problem with the lottery either, I just don't think people should count on it for retirement income.

Assumption #3... are you saying the contribution limit should be raised (I'd agree with that) or that employees can't afford to contribute enough to fund their retirement?  I'd disagree with that last part, they'd just have to shift their consumption expectations, which seem to be way out of whack.  Yes, there are absolutely some people who can't afford to contribute, but I don't see that as a problem with the 401K.

It's a problem with an retirement plan that depends on employees contributing enough to fund it properly.  If you want to call it a savings plan, I would feel better about the whole thing.

#4... isn't that be the case whether one uses a 401k or not?  I really don't see that issue as being distinct to 401Ks in any way... same for assumption #5.

I guess what I'm getting at is if we are going to tell people that a program is for retirement, there should be some way of actually using it to provide reliable income in retirement.  If we are going to say that the program is just a savings plan, and that it shouldn't be relied upon for income needs in retirement then it's just a tax advantaged savings account, and that's fine.

Would you suggest one just saves outside of a 401K and pays the taxes on contributions now and earnings along the way or are you leaning more towards corporate and/or government control of retirement?

From a policy perspective, if the government is going to make rules about how retirement plans must be designed, it seems like these rules should be geared toward plan designs that can actually achieve their objectives, rather than just provide fresh money for Wall Street to churn.

In other words, without regard to the current systems in place and working from a completely blank slate, how do you think our retirements should be funded?

When you are talking about a whole nation, lifetime retirement income requires the pooling of risk, just as it does with health coverage.  An orderly and inexpensive way of participating in a simple lifetime income annuity that is fully funded from an actuarial perspective would be a good place to start.

I am just venting to some extent.  It bothers me that the 401(k) plan model encourages the formation of expectations that are, to me, usually unrealistic.  What would be more realistic would be higher savings rates and lower retirement income expectations that can actually be met.

[MediumTex]

MT,

Aren't we forgetting about Social Security here?  It seems to me if a couple has their home paid off and pulls in about $30k per year in Social Security (not unreasonable)... then less than $500k in retirement savings should be ok if their frugal and properly insured. 

Social Security is all a lot of people will have when their 401(k) account is depleted two or three years after they retire.

Social Security is what will prevent the 401(k) plan concept from completely ruining a whole generation of retirees.

[moda0306]

I know we're running these conversations on 2 threads at once, but 401k plans and IRA's are simply retirement savings programs.  I think if retirees don't have enough to retire, it's their own misinterpretation of what their 401k balance was all about, not the inherant flaws of the 401k, that are at fault.

You and I both understand it's a glorified savings account with investments and tax-deferral features.  It's not a hidden fact to most Americans.

What alternative do you suggest?  Another annuity program? 

[MediumTex]

What alternative do you suggest?  Another annuity program?  

To me, a "retirement" program must be expressed in terms of an annuity.

The whole concept of retirement presupposes a means of achieving lifetime income replacement.

***

Understand, too, that I have a different perspective than most people on retirement plans, just as the sausage factory worker would have a different perspective on breakfast meats.

[stone]

What worries me is that people somehow suppose that stock/bond/rare stamp/whatever based pension plans are something other than an ongoing transfer from the people working to the retirees. If you are terribly clever and your 50% rare stamp:50% Greek stocks retirement portfolio does terribly well- then all that means is that you have a greater claim over people of working age when you retire. If every retirees does similarly well and so all workers are run off their feet then that will cause inflation. If all retirement plans go belly up then that will simply mean more working age people are unemployed who otherwise would have been working to provide stuff bought by retirees. Maybe I'm stating the obvious but I sometimes sense that people are going misty eyed imagining that somehow the savings are "working" during the intervening period and that somehow something real is transfered to the future.