Guy I know has found himself in Dutch with credit cards to the tune of 35 grand.
He’s 60 and plans to work until he’s 67.
He’s planning to take a debt consolidation loan or a loan from his 401K. I didn’t know what to tell him.
Any advice on which would be better?
If he can borrow from his 401(k), that is probably the better deal, because when you do that you pay the interest back to yourself.
Borrowing from your 401(k) allows you to tap into your retirement savings without paying immediate taxes or penalties. The amount you can borrow has limits, though, typically capped at 50% of your vested balance or $50,000 (whichever is less).
You pay the money back to yourself with interest over a 5-year term, but risk severe taxes and a 10% penalty if you leave your job and cannot repay it.
I’m sure there are rules specific to his plan. He should check with his plan administrator.
between the two, I would generally agree with robby that a 401k loan is probably better, PROVIDED that he can still contribute to and get employer matching contributions to the 401k. If he owns a house, he could also consider a home equity loan.
Do you know the interest rate of the debt consolidation loan? And the details about his 401k, like balance and rate of return for the investment funds?
In his case, a 401k loan should be pretty safe since he’s over retirement age. He can withdraw from the 401k without penalty, although he’d owe taxes on whatever he takes out. If he had to, he could pay off the loan by making a 401k withdrawal of the remaining loan balance. Or maybe there’s a way to convert a 401k loan into a normal 401k withdrawal. But if the debt consolidation loan is at a low interest rate and his 401k has a high rate of return, it might make more sense to do the debt consolidation loan and let the 401k keep making money.
Also, does he have a plan to live within his means? If he’s used to living the high life on credit, it may be hard to scale back. He shouldn’t put another $35k back on the CCs after he pays off the current balance. Having a plan to get his spending under control should also be part of this process.
No need for 401k loan, once you reach 59 1/2 you can withdraw whenever you want. Of course, you pay tax on the withdrawal. Of course, taking $35K from 401k may hinder his retirement plans. I guess I’d see what kind of terms he could get on a debt consolidation loan, pay it for a few years and by that time he’ll have more in the 401k and pay off a smaller balance later.
I generally agree with @robby but would add that while you are paying yourself back with interest you may be missing out on gains depending on the market between now and when the loan is paid off. Of course if it’s a bear market, you are doing better financially.
This is general advice. There may be details with your friend’s situation that significantly change the calculus. I took out one of these loans a while ago. Things may have changed but I recall that they money was taken out of my paycheck for five years in equal installments. You couldn’t pay it off more quickly but you could pay off the entire thing at any time in a lump some.
Shit. I missed that. You are exactly correct. In this case it will be taxed like ordinary income which may be harsh on top of his regular income. The loan may be a better choice but that was a very important point to make,
[Moderating]
Since this is asking for advice, it’s a better fit for IMHO. Moving.
If he doesn’t mind his credit being shot, and if the 401k represents the bulk of his net worth, bankruptcy might be an option. 401k plans are usually protected in bankruptcy proceeding. It’s an extreme move with plenty of downsides, but it is an option worth exploring. I don’t advocate for it, and it depends on his exact circumstances if it makes sense, but it is an option.
Aren’t you required to immediately pay back a 401(k) loan if you leave your job? That might be a consideration.
Here’s a question:
Does taking a loan on a 401K affect credit?
I doubt it, as it is secured by the 401k funds. If he fails to pay, the plan just simply issues a 1099-R and declares it a taxable distribution. Taxes are then due.
I don’t know if 401k loan payments are reported on credit reports.
The guy is 60 and $45k in debt. I don’t think he’ll be borrowing anything anytime soon.
After reading the OP again, I think a bit more information is needed. The friend apparently has the means and willingness to repay the debt, so let’s take bankruptcy off the table. Now the question is down to a couple of considerations. The first is the lowest cost of repayment, in which case the the 401k loan is probably the best option. The other consideration is credit rating, and whether or not if it is worth repairing or rebuilding if he is already in arrears. If he is already late 30 days or more on the credit card debt, his credit has taken a hit, and a debt consolidation loan that reports to credit bureaus might help rebuild his credit. On the other hand, if he is current on his credit card payments, then simply paying them off in full using a 401k loan is fine. The credit cards will report the debt as paid as agreed and there is no credit hit that needs to be repaired.
I would go for the 401k loan for a couple of reasons. First, lower overall cost. Second, negative hits on a credit report drop off after seven years, and he plans on retiring in seven years, so I wouldn’t be too concerned about having poor credit in the meantime. His priorities may well be different though, and total 401k balance at retirement is important.
He told me 35K but same difference
I was just wondering if taking a loan on a 401K affected a credit score. Which he said was currently at 710, mostly because of his CC debt. He said he hasn’t missed any payments but the monthly payments are starting to swallow his head (his words).
The possibility of being laid off while that loan is out is pretty scary. You are out of a job with no money coming in and can either come up with the cash to pay off the loan or blow away your retirement savings.
since I just went through debt consolidation myself, you can make payments in addition to required amounts
I was specifically referring to 401k loans, not regular debt consolidation loans.
my bad, misread