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401k loan payoff question

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Talking401k
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401k loan payoff question  Reply with quote  

Hi,

My Wife has a 10k loan she took out from her 401k. We have 16k in savings and are thinking about paying off the loan. Would you recommend using 10k from our savings to pay off the 401k loan? Are there any repercussions to paying 10k from our savings into the 401k? Can our taxes be affected at all? Any advice or information is great! Thank you
Post Thu Sep 04, 2014 6:13 pm
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blixet
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No tax repercussions beyond the fact that you are paying off a loan of pre-tax dollars with after-tax dollars which is not a particularly good thing. As long as you don't end up needing the money and have to take out another 401k or other type of loan, might as well pay it off. Hopefully, you can make more over the term of the loan in whatever it is invested than in the bank where it is probably earning zip.

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Post Thu Sep 04, 2014 6:40 pm
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Wino
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quote:
Originally posted by blixet
...you are paying off a loan of pre-tax dollars with after-tax dollars which is not a particularly good thing.

There is no correlation. He spent the borrowed money just like after-tax dollars, so he owes after-tax dollars to repay it.
Post Fri Sep 05, 2014 12:32 pm
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blixet
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When a borrower repays a 401k loan, they are contributing after-tax dollars to a pre-tax account. That money will be taxed a second time upon withdrawal, assuming they don't owe zero taxes in retirement.

So if one borrows $10,000 and is in the 25% tax bracket currently, it would take $13,333 of new earning to replace it in the 401k rather than the original $10,000 pre-taxed earnings. It's been taxed once now. But it doesn't get special treatment in the 401k account. It is considered pre-tax dollars and will be taxed again at withdrawal.

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Post Fri Sep 05, 2014 2:02 pm
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oldguy
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I agree with wino. The borrowed $10k had the purchasing power of after-tax $10k and was used as such. The new after-tax $10k 'resets' the status of the 401k.

But regardless of how you think about it - the current position is that she owes $10k to her 401k.

IMO, it comes down to interest rates. Eg, I keep our taxable money in the SP500 Index where it has averaged 11%/yr for over 30 years - so anytime that I can borrow longterm money for less than 6% or 7% and leave mine invested it at 11%/yr, that is my choice. Conversely, if your savings is actually in a low-interest savings account (1% or 2%), then it is costing you money each year to borrow from the 401k and get a much lower rate in return.
Post Fri Sep 05, 2014 3:31 pm
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Wino
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quote:
Originally posted by blixet
When a borrower repays a 401k loan, they are contributing after-tax dollars to a pre-tax account. That money will be taxed a second time upon withdrawal, assuming they don't owe zero taxes in retirement.

Yet, it would have taken that exact same $13,333 in earnings to spend the $10K already spent, which was spent without taxing it, so the OP is paying taxes on $13,333 ONE time, and has $10K untaxed in the account, which will be taxed upon withdrawal. Net change: zero.

What the OP lost was opportunity cost of the money no longer earning in the 401K, because it was borrowed and spent instead of compounding at the recent very good stock market performance.
Post Fri Sep 05, 2014 4:03 pm
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blixet
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In thinking about it further, I see your point. Thanks. I still think that the interest which is paid back to the 401k account would be taxed twice, but haven't put much effort into thinking about how significant that could be or what factors would affect it.

I guess in terms of the OP's question, it is moot anyway.

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Post Fri Sep 05, 2014 7:37 pm
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