The overall rate of return on my 401k since I started my job has been 5.71%. I have several thousand dollars in the account.
I have a private student loan that has a 7% interest rate, with a very high balance. Paying it off is a sloooow process.
I don’t have enough in my 401k to wipe it out, but if I borrowed against the 401k, I could definitely take out a huge chunk of the principle and presumably be paying a lot less in interest each year on this loan.
I also have a car loan that is fairly high interest rate but about half the size in principle (the joy of having little credit history and no one to cosign with). I could entirely pay off the rest of my car loan by borrowing against all of what I have in my 401k (if that’s allowed).
So, what’s the best thing I should do, financially? Would a loan from my 401k behoove me in these circumstances?
Bad idea. You should only borrow against your 401(k) in emergency situations. If you were up against an imminent bankruptcy, that might be a good reason. I’d just make some sacrifices and concentrate on working down your student loan debt.
Alright thanks! Good to know that 401k loans should only be used in emergencies. I literally knew nothing about them and thought that with the rates of return vs loan interest rates, I might just be throwing money down the drain (by not paying off debt using a loan that I will just then repay back to myself).
You have to use after-tax money to pay back your loan, so you’re essentially paying taxes twice. If you can’t pay it back or lose your job you could face significant tax consequences. It’s not a good risk at all.
Even with an imminent bankruptcy, my understanding is that it’s still a bad idea, because retirement accounts are safe in the bankruptcy process, that is, they can’t take money from the accounts to pay other debt.
Also, drewtwo99, IIRC, there are only very specific circumstances when loans may be taken from 401k accounts - it’s tied in to the purchase of a home or extreme financial distress. And payouts can only be taken when you’ve left a job.
Lsura, that directly contradicts what a personal friend told me (he has taken out loans against his 401k a few times, no extenuating circumstances necessary).
Regardless, I’m not considering it anymore since it seems to be an emergency only thing.
If you’re trying to avoid bankruptcy, then it’s often worth the sacrifice.
Also, you can take a loan from most major k plans for whatever reason strikes your fancy. Distributions are usually only allowed without penalty after age 59 and a half, unless you can demonstrate that they represent a reasonable retirement income earlier than that. Some allow hardship distributions, but not all. Whether or not you’re still at the company you opened the plan with is irrelevant.
On the plus side, all the interest is paid back into your own account, so you’re basically paying zero interest. However the more significant loss is that you’re missing out on the opportunity to further invest in your 401(k). Your contributions will be zero for as long as you have an outstanding loan in your 401(k).
Another downside to 401k loans is that if you lose the job, typically the loan comes due. If you don’t have the money to pay it off, you pay tax and penalties too.
As a federal employee, I had something equivalent to a 401k and I did take a loan against it. My reasoning was that I’d be paying it back to myself, including the interest, it was cheaper than taking out a personal loan, and at the time, having a government job was still a very secure thing - no talk of furloughs back then. And we paid it back fairly quickly, so for us it was a win all around.
Based on what you’ve shared, I’d recommend you make minimum payments on the lower interest loan, and throw all extra cash against the principal of the more expensive loan to wipe it out as soon as possible. Then take everything that went to the paid-off loan and throw it at the other debt. That’s how we wiped out everything but our mortgage.
Just work out the difference in what you’d pay over time. If it’s close, don’t bother. If the loan will save you a lot, go ahead and do it. Especially if you’re young when you’ll have plenty of time to build up retirement funds. There’s nothing magic about 401Ks, they’re investments, and you can calculate their value and the savings you can obtain by using them to reduce debt. But like any other investment, don’t cash it in to save some insignificant amount of money.
I’ve never done it, but I don’t remember rules about emergencies for loans - they cover actual withdrawals. Here is the IRS summary of 401K distributions - the loan section is near the bottom.
The plan I was in forced you to stop contributing while the loan was outstanding. Check your plan. This is a big negative, since you stop saving for retirement and lose matching funds during this period, and they will probably more than outweigh interest benefits.
I have TSP, not 401k, but this might apply there as well. If I were to be granted a loan against my TSP and lose my job, that loan would come due as a balloon payment because there’s no paycheck from which to draw repayments.
You can take out a five year loan against your 401k for any reason you want. You can only borrow up to half of the amount that you have in the account. There is no penelty for doing so. You pay yourself back, with interest, in installments from your paycheck. I think that the interest rate is 4.25%. You miss out on any gain that the money would have earned but also any loss. There are some weird restrictions on how to pay it back early but you can do it.
There is a 30 year 401k loan too but that one does have restrictions for how it’s used.
Are you contributing more than the minimum necessary to get the full company match (assuming there is a match)? In that case, you should definitely consider reducing your contribution and moving that money over to your loan payment.
If you are just contributing the minimum, you’ll want to think about the tradeoff between the lost company match against the loan interest rate. I would guess you’re better off with the match, but don’t know how to figure that out.
If you do reduce/suspend your contribution, make darn sure you start it back up again when you get the student load under control.
Thanks for the info everyone I am making the minimum contribution in order to get the company match.
I am also paying more than the minimum (well more) on my student loans and they are getting paid off. I would not say they are “out of control” or anything like that.
I think at this point I’ll just keep paying off the loans at whatever rate I can afford (which is a good rate), and skip the idea of doing the 401k loan.
If only allowed to borrow up to half the amount, it wouldn’t make that much of a difference anyway (I was unaware of that restriction).
If you have only earned just under 6% on your money in your account, over what time period is that? If it’s over the past few years, sounds like you have your investments heavily weighted towards fixed income (bonds) as equities have significantly performed better than that over the past couple of years. How old are you? If you are under 50, then you should consider changing your allocation to more equity exposure.
It is only under the past couple years (since Summer 2011). I’m pretty sure I chose to do a fairly “high risk” investment because of my age (26). I thought it was performing pretty well at 5.7% but I guess not?
You’re saying I should look into changing my allocation? Wonder if I can do that online…
I am making the minimum contribution in order to get the company match.