Talk:401(k)

Borrowing from your 401k

I’d like to question your statement that “Loans are paid back by post-tax monies, so there are substantial tax implications in taking a loan from pre-tax monies.”

It seems to me this is bogus reasoning. Consider, for example, a simple case in which I borrow $50,000 from my 401k, keep it in my sock drawer overnight, and then pay it back. I’m not paying the loan back with “post-tax monies”. It’s the same pile of money, and no taxes are paid. Now, you can argue that this example is not realistic, but it strips the transaction down to its bare essentials, and the truth it reveals holds in more complex scenarios.

Next consider that I need $50,000 to buy a gas-guzzling Hummer. I don’t have the cash, so my choices are to borrow commercially or borrow from my 401k. If I borrow from my 401k I take out $50,000 and I repay $50,000 plus interest. If I borrow commercially I leave the $50,000 in my 401k, and I borrow $50,000 from the bank and repay the $50,000 commercial loan plus interest. Either way, I have to repay the $50,000 capital. It’s irrelevant that the money is indeed “post-tax” because I paid income tax on it as I earned it: there’s no additional tax penalty on the capital when I borrow from the 401k vs. borrowing commercially.

Now let’s look at the interest. Consider your finishing position in the two scenarios described above. If you borrow from your 401k, at the end of the loan period you have the $50,000 returned to your 401k, plus the loan interest. If you borrow commercially, at the end of the loan period you have the $50,000 in your 401k (it never moved), plus the investment return earned on the $50,000 during the loan period. If your 401k is invested in interest-bearing instruments like money market and bond funds, you’re probably worse off borrowing commercially because you typically borrow money at a higher rate than you can make on it. (We could get into a lot of arcane tax detail here, e.g., deductibility of interest on a home equity loan vs. later taxing of the interest you pay yourself in your 401k, but these are second-order issues.) If, on the other hand, your 401k is invested primarily in stocks, your finishing position is that you either have loan interest (guaranteed) or stock gain (or loss) in your 401k. Essentially, this means that if you choose to borrow commercially rather than from your 401k, you’re borrowing money to invest in stocks, which in my mind is always a bad idea for individual investors.

Now there is a very good reason not to borrow from your 401k, and it’s that you have to repay the loan immediately if you lose your job. That’s a serious risk. But not for everybody. Let’s consider a third situation, which is my own. I need money to pay for my sons’ college tuition. I have the money in traditional IRA’s, but I’m in such a punitive tax bracket that if I withdraw the funds from the IRA (penalty free, thanks to the exception for tuition), the government will take half of it. Borrowing from my 401k therefore looks attractive. Do I need to worry about losing my job and having to repay the loan immediately? No. If I lose my job, I can repay the loan by withdrawing from my IRA. As long as one of the boys is still in school (true for the next three years), I don’t pay a penalty, because it costs as much for a year at college (almost $50,000) as I can borrow from my 401k. Furthermore, if I lose my job my income will plummet in that tax year, so I’ll pay far less tax on the IRA withdrawal. In short, I have a good emergency plan to combat that one valid reason for not borrowing from my 401k. —Preceding unsigned comment added by Chicago07 (talk • contribs) 19:50, 24 November 2007 (UTC)

As far as I know, you're right. Many popular financial writers contradict you, and as far as I know, they're just wrong. The tax treatment of a 401(k) loan, if it is repaid on time, is designed to be identical to that of any other loan.

Simplifying, one might imagine a world with one interest rate: you can buy a money market fund in your 401(k), and that returns 10%, or you can borrow money from your 401(k) at 10%, or you can borrow money elsewhere at 10%. I have $30k the plan, and I need a $10k loan, that I will repay a year from now.

I could borrow from my 401(k). In that case, I have $20k left invested in the fund. At the end of the year, my fund has grown to $22k, I've repaid the $10k loan, and I also paid $1k interest. So the plan is at $33k. The loan wasn't a taxable event, so my tax situation for this year was unchanged. I paid $1k in after-tax interest.

Or, I could borrow the money commercially, and leave my 401(k) untouched. In that case, I've got $30k invested in the fund. That grows to $33k by the end of the year. Once again, my tax situation for this year is unchanged, and I've paid $1k in after-tax interest to the commercial lender.

A real 401(k) might invest in stocks, or other instruments that achieve a higher return than the interest rate you're paying on the loan; so you might be losing out a bit more on your investments than in the example above. But, you've also avoided the risk. (If you prefer, then you can take out a margin loan, and use that to buy more stock, to get your risk and return back up.) 74.61.11.168 (talk) 10:48, 19 December 2007 (UTC)

If you borrow from your 401(k), you pay it back with post-tax money. Then when you withdraw from it later (say, at retirement), you are taxed again on everything. This is detailed, for example, on the Fidelity FAQ about 401(k) loans. Omehegan (talk) 00:22, 7 August 2008 (UTC)

Fidelity states (correctly) that a 401(k) loan is repaid with after-tax dollars. This does not mean that these loans have tax disadvantages, or that you somehow get taxed twice! The "income" that you received when you borrow the money is not taxed; if you imagine borrowing ten thousand dollars from your 401(k), then repaying it the next day, then it should be obvious that your tax obligation for the current year is unchanged, and the balance of your 401(k) is unchanged. The tax treatment of 401(k) loans is identical to that of any other loan. 96.26.222.129 (talk) 21:48, 13 February 2009 (UTC)

Then, isn't the last sentence of the Wikipedia paragraph covering this topic incorrect? Currently it says the opposite, with "Therefore, upon distribution/conversion of those funds the owner will have to pay taxes on those funds a second time." Asked another way, is there a "NOT" missing before "have to pay taxes on those funds A SECOND TIME." ? Thhowl (talk) 16:41, 19 July 2011 (UTC)

Ted Benna

It seems he should be credited with discovering the 401k. Here is a story about him at Time Magazine http://www.time.com/time/80days/800920.html How about a brief mention in the history section. 05:47, 1 March 2009 (UTC)jojopuppyfish —Preceding unsigned comment added by Jojopuppyfish (talk • contribs)
Although Ted Benna claims to be the father of the 401(k), this is disputed by other people familiar with the introduction of the first 401(k)'s.

My link is often reverted. why?

The links I submitted were for the individual blog entries which are purely informative in nature and have no commercial interests in them whatsoever.
Hence I kindly consider the links in your external links section.
spam://www.brooklyntroy.com/index.php/blog/Using-your-Self-Directed-IRA-to-obtain-non-recourse-loans.html —Preceding unsigned comment added by Sundar77 (talk • contribs) 09:18, 26 October 2009 (UTC)

Looks like it was reverted automatically by a Bot. This is down to external link policy WP:ELNO - links normally to be avoided: "Links to blogs, personal web pages and most fansites, except those written by a recognized authority. (This exception is meant to be very limited; as a minimum standard, recognized authorities always meet Wikipedia's notability criteria for biographies). " Cassandra 73 (talk) 13:03, 26 October 2009 (UTC)

Can i resubmit the links to the blog? Please advice. —Preceding unsigned comment added by 202.129.197.234 (talk • contribs) 05:07, 30 October 2009 (UTC)

Appreciate that this appears to be a professional's blog and not the opinions of a random person as some blogs are, but it doesn't seem to meet the exception criteria above. Cassandra 73 (talk) 12:25, 30 October 2009 (UTC)

how can I find if my dad which died years ago had a 401k.

How can I find the amount of 401k my dad had cin2524@yahoo.com thank you for your help. —Preceding unsigned comment added by 74.78.178.47 (talk) 19:16, 25 July 2010 (UTC)

Risk

I plan to put the following 2 paragraphs on the main page:Attorney18 (talk) 15:34, 24 October 2011 (UTC)

Unlike defined benefit ERISA plans or banking institution savings accounts, there is no government insurance for assets held in 401(k) accounts. Plans of sponsors experiencing financial difficulties, sometimes have funding problems. Fortunately, the bankruptcy laws give a high priority to sponsor funding liability. In moving between jobs, this should be a consideration by a plan participant in whether to leave assets in the old plan or roll over the assets to a new employer plan. Attorney18 (talk) 10:38, 22 October 2011 (UTC)

Recent court decisions have vastly increased the risk associated with holding assets in company sponsored defined contribution accounts. Prior to these court decisions, the contributions made into company sponsored defined contribution accounts could not be reduced due to the anti-cutback rule of ERISA §204(g)2, which prohibits the reduction of accrued benefits or the imposition of greater restrictions on the receipt of accrued benefits. However, since 2007 in the case: Register v. PNC Fin.Servs. Grp., Inc., 477F.3rd 56 (3d Cir. 2007), the courts have held that plan sponsors may take back prior contributions to defined contribution accounts. As the plan sponsor owns all defined contribution accounts until the moment of disbursement, the courts allow the sponsors to take back contributions, not distinguishing between the sponsor attributable contributions and the employee attributable contributions. In the June 2011 case: Engers v. AT&T, 10-2752 (3d Cir. 2011), that also relied on the case: Jensen v. Solvay Chemicals, Inc., 625 F.3rd 641 (10th Cir. 2010) the court legitimized the action of a large, continually profitable, national employer that instituted a policy to take back all the contributions made to employees’ defined contribution accounts. In the 2011 Engers case, the employer, AT&T, felt it had over-compensated its older workers in prior years and had instituted a policy of taking back the contributions to such employees’ defined contribution accounts at the moment of each employee’s retirement. As this policy would be upsetting to its workers, the company publicized its continued annual contributions to employee defined contribution accounts, including providing periodic, detailed bookkeeping statements, without informing the employee it was also taking back all the contributions it was making at the time an employee requested disbursement. Some employees had 8 years of contributions, the entire assets of their defined contribution account, taken back. The courts condoned AT&T’s actions. Participants in pension plans having defined contribution accounts may wish to consider whether they should withdraw company contributions as soon as received, even though suffering penalties, rather than running the risk of having the sponsor take back all account assets at the time the employee requests disbursement.Attorney18 (talk) 15:34, 24 October 2011 (UTC)