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,