401K loan

46 Replies

Originally posted by Jeremy Paris:
I just requested my 401k loan last night. Unfortunately for me I am needing to pull the funds for paying debts, but after that I will have about $10k left so I am thinking of using it on an investment property....a cheap one....like in my hometown of Buffalo.

For me it was straight forward. I didn't even have to specify what it was going to be used for, and it had the same terms as if I pulled a loan for a property. It said I should have a check in 3 business days.

Hey Jeremy,

You obviously have a better understanding of your finances than I do, but I would caution against being over-leveraged. A 401K is still debt - it's just a different type of debt. It sounds like you're getting things in order, and that's awesome, but you may want to build up a stronger cash reserve before buying a property.

I could be way off - just my two cents.

Originally posted by Bily Elliott:

There are a few OTHER properties that are foreclosures, not short sales, that have come on the market in the last few weeks in the area I already have a rental and that I want to stay in. My plan now is shortly after the new year I will take out a loan for 30K and make a cash offer or two on some of these properties that are listed in the 30K range. Hopefully I can get a GREAT deal on a property or two, get them rented out, then save up those rents and roll them into more properties. That is my plan anyway!

Awesome - congrats man! I've never done this, so I'm interested in your order of operations - will you pull out the cash and then offer, or vice versa?

The details of these plans vary. At various times I've had these loans with four different employers. Only one of the four allowed you to continue to repay the loan after you left. The other three required it be repaid pretty quickly if you left, 90 days, IIRC. One allowed up to three loans at once. The others allowed only one at a time. The longest time I encountered for a primary residence loan was 10 years. I believe my current employer allows only five, even for a primary residence.

I realize I'm late to this party, but to emphasize what Steve Hamilton said, these loans are VERY employer-specific, and the details can vary depending on which investment provider recordkeeps the retirement plan. I work for one of those companies and spend half my days processing loans from retirement plans.

Some plans allow only one loan at a time, but I've seen plans that allow 2, 5, 25, and an unlimited number of loans, as long as you don't exceed the IRS maximum of $50,000 or 50% of the vested balance, whichever is less.

For a general loan, which can be used for anything, the maximum term is usually 5 years. For home loans, I've seen it range anywhere from 10 years to 20 years.

The home loan is generally only available for buying a primary residence, and some require a signed purchase and sale agreement, while others require no documentation at all.

Processing can range from just a phone call and express mail check (you get the funds in just a couple of days), to paperwork that has to be signed by you, signed and notarized by a spouse, and signed by the employer, which can take longer.

Interest rates can vary and are generally very low (prime plus one is typical), but you are paying the interest to yourself, right back into your retirement account, rather than to a third party (which is why many people take out these loans to pay off high credit card debt). These loan are also not reported to credit agencies, so they don't affect your credit score at all.

Some repayments are done through payroll deductions (biweekly, monthly, whatever your pay schedule is), but many are now done as direct debits from your own checking or savings accounts, not through payroll. For those done via payroll deduction, if you leave the employer, some will require the loan be paid back in full or it defaults (no effect on your credit, but the outstanding balance becomes a taxable distribution with ordinary income tax and 10% early withdrawal penalty if you're under the age of 59 1/2), but some will allow you to switch to direct debit and continue the payments according to the original schedule. Those that are set up originally as direct debit payments always allow you to continue the payments if you leave employment. If you process a full payout or rollover and have an outstanding loan, the loan will default (again, no effect on credit score, but it becomes taxable).

As long as you pay the loan back, you won't pay taxes or penalties for taking the loan. However, one thing to keep in mind, which is rarely discussed, is that the interest you pay back to yourself on the loan ends up getting double-taxed (assuming you've contributed and are borrowing pre-tax funds). The principal comes out of the plan and goes back in, but the interest comes out of your pocket as after-tax money, is paid back into the plan as pre-tax money, and you pay taxes on that amount again when you withdraw the money (presumably when you're retired). The longer you stretch out the term, the more interest you'll pay, and the larger that double-taxation becomes. It's not a huge consideration, just something to be aware of.

Most plans allow you to pay the loan back in full at any time with no early payment penalties. Some will also allow you to make partial payments during the term of the loan, but some won't. The early payoff can sometimes be done at any time (even the day after you take the loan), but some do require you to wait a specific period, usually after one year.

Another thing to keep in mind is that the IRS calculation for what you can borrow is actually the lesser of A) $50,000 or B) 50% of the total vested balance minus the highest outstanding loan balance over the past twelve months. So if you borrowed $50,000, and paid it back after a month or two (you don't always have to wait a year before repaying), then you'd have to wait 10 months or so before a new loan would be available to you, because your "highest outstanding loan balance over the past twelve months" would be $50k. $50k minus $50k is zero.

And while the IRS says you can borrow 50% of the vested balance, your employer can also restrict the sources of money available to borrow against. For example, if you contribute and your employer matches, they may only let you borrow half the amount you've contributed, not the employer match.

Sorry for the long post!

@Bily Elliott

Another option if you qualify is to role your money into a solo 401k with check book control. Once your money has been put into the solo401k you can purchase real estate using leverage. A lender will want a 30-40% down payment as it is a non recourse loan, but it does let your retirement monies grow faster. Just make sure you do all of your due diligence.

I have been reading many of @? posts tonight on other topics, he is a wealth of information and I have found him right on in his comments.

I am being told that I can only get a hardship load through my 401K for the following reasons:
? purchase of a primary residence;
? post-secondary education expenses;
? to prevent eviction or foreclosure from your primary residence;
? unreimbursed medical expenses;
? adoption-related expenses;
? payment for burial or funeral expenses for your deceased parent, spouse, children or other dependents;
? expenses for the repair of the damage to your principal residence that would qualify for the casualty deduction for federal income tax purposes.

Has anyone heard of this? I have enough to get a loan for the max, but want a personal loan to help with my investments. Thanks

I am being told that I can only get a hardship load through my 401K for the following reasons:
? purchase of a primary residence;
? post-secondary education expenses;
? to prevent eviction or foreclosure from your primary residence;
? unreimbursed medical expenses;
? adoption-related expenses;
? payment for burial or funeral expenses for your deceased parent, spouse, children or other dependents;
? expenses for the repair of the damage to your principal residence that would qualify for the casualty deduction for federal income tax purposes.

Has anyone heard of this? I have enough to get a loan for the max, but want a personal loan to help with my investments. Thanks

Yes, Stephen. Some plans allow loans (for any reason) as well as hardship withdrawals (for the reasons you noted), but there are some plan that consider a loan to be a hardship and apply the same restrictions. It all depends on the employer.

@Greg Powers Greg, thanks for the clarity on this. I can only echo what you've said so well already. But echo I will. Whether you can take a loan or not, how much you can take, which assets you can use, and other benefits such as In-Service Distributions are EMPLOYER SPECIFIC!

Check with your employer.

Check with your employer.

Check with your employer.

Your plan may treat you like an angel and my plan may horse-whip me. I have seen plans that allow NO BORROWING for any reason whatsoever. To get your money out, you must quit your job. End of story. Who needs a plan like that?

Oh, BTW - Check with your employer.

@Bily Elliott This little tirade was not meant for you, but for all the other posters. I know it's easy to believe that all plans treat everyone alike, but unfortunately, that is not true. Good luck with your real estate investing! Keep thinking outside the Wall Street Box!

Originally posted by @Mike McDermott :

Whether you can take a loan or not, how much you can take, which assets you can use, and other benefits such as In-Service Distributions are EMPLOYER SPECIFIC!

Check with your employer.

Check with your employer.

Check with your employer.

Right. The best one can say here is what the IRS allows or even what their particular employer allows, but that's it.

The Solo 401(k)s have their own rules as well, my solo happens to be with Schwab, and no loans are permitted. For those who aren't comfortable with the self-directed flavor of putting the real estate inside an IRA/401, etc, creating Solo 401(k)s for both spouses at a custodian that permits loans is an interesting way to have $100K (total) at the ready. A 5 year payback on $100K is nearly $1900/mo, but still far better than hard money, and keeps the retirement money in tact with no risk of "getting fired" and forced to pay penalty/taxes.

I hate to bump an old thread, but I have to.  I'm doing a little research on using 401k loan as a down payment and I need to say - @Greg Powers  , thank you thank you THANK YOU for this little gem.

However, one thing to keep in mind, which is rarely discussed, is that the interest you pay back to yourself on the loan ends up getting double-taxed (assuming you've contributed and are borrowing pre-tax funds). The principal comes out of the plan and goes back in, but the interest comes out of your pocket as after-tax money, is paid back into the plan as pre-tax money, and you pay taxes on that amount again when you withdraw the money (presumably when you're retired). The longer you stretch out the term, the more interest you'll pay, and the larger that double-taxation becomes. It's not a huge consideration, just something to be aware of.

It has been driving. me. CRAZY trying to figure what the tax implications are of this.  At first I thought there was no issue, but something about paying it off with after-tax dollars didn't jive.  Then I thought - well if I were to dump the same amount of money into say, a savings account, then it'd be after-tax money so what's the difference?  Then I freaked out, thinking I'd be paying double taxes on ALL of the money.  It's one of those nagging things that I just couldn't put my finger on it, couldn't figure out the right search term to google, but just couldn't see the big picture.  Paying double taxes on the interest makes all the sense in the world to me.  I can finally sleep at night.  Thank you ;)

Oh, and @David Beard  - 4) Absolutely! It works just like a company 401K. Now, if you create two related small businesses and divide your company 401k funds between two new SD401K's in order to try and get $100K of loans ($50K from each), then you are on very thin ice with the IRS at that point, per my administrator. Believe me, this thought occurred to me almost immediately, so purge that thought from your head!

That was literally the first thing that jumped into my head as I was reading about rolling funds over from your employer into a self-directed 401K where your LLC is the plan administer ;)

Also for the record - my employer allows 7 years repayment period for a primary residence loan, and up to 5 years for all other loans.  Just thought I'd throw that out there since everyone else seems to be allowed 10 or 15 ;)

Again, sorry to bump the old thread I'm just so grateful to Greg for solving that equation for me :)

Hi Sam & Heather Jones   Glad the information was helpful.  That little tax implication is one of the hardest things to explain to people who are taking out loans.  Most people--if they even consider it--think ALL the loan repayment is getting double-taxed.

The biggest problem I've seen with these loans is that the payment period is so short.  The payment on a $50,000 loan over the five year maximum can certainly put a dent in your cash flow.

Good luck with your investing!

Thanks for all the good information. I was just about to post a question regarding using my SD401k to pay cash for a foreclosure. So, there's no ifs,ands, or buts to the 50k per year? If so, I'm thinking that instead of using a property I'm looking at as a rental I can use it as a flip and use the money from that for a rental.  Next year, repeat. I will run all the numbers but I am hoping this sounds like a good start for me.  Thank you!

@Lynn Maher  --yes, $50k is the max, but not per year.  That $50k is an absolute maximum.

The actual IRS calculation is the lesser of: 1) 50% of your total vested balance, or 2) $50,000 minus the highest outstanding loan balance over the past twelve months.  So....

If your vested balance is $80,000, you can take a loan out for $40,000 (assuming your employer or the plan doesn't restrict any sources of money).  If your vested balance is $200,000, you can still only take a loan out for $50,000.  And if you take out a $50k loan on Oct. 20, 2014, and have a $48,000 balance on Jan. 1, 2015, you can't take another $50,000 out.

Also, to emphasize another point I made above, the second half of that IRS calculation can be tricky.  Let's say you take out a loan for $50,000 to buy a flip, you do the rehab and sell it in four months, then pay back the $50,000 loan.  You won't be able to take another loan out for another eight months because the IRS calculation is seeing that "highest outstanding loan balance over the past 12 months" as $50,000, and according to the calculation, $50,000 minus $50,000 equals zero.  Or say you take a loan out for $35,000 and pay it back in six months; over the next six months your maximum loan amount might be $15,000.

And again, to kick a dead horse another time or two, THIS IS ALL EMPLOYER SPECIFIC.  I have seen one employer that only allowed you to borrow 25% of your vested balance.

Thank you Greg Powers! Good info. At least my plan is self directed and I don't have an employer to worry about. Best thing to do at this point is call vanguard (where my 401k is) and get the specifics from them.

Originally posted by @Lynn Maher :

Thank you Greg Powers! Good info. At least my plan is self directed and I don't have an employer to worry about. Best thing to do at this point is call vanguard (where my 401k is) and get the specifics from them.

401k plans are considered to be employer-sponsored plans. IRA's are not - they are Individual Retirement Accounts. Lynn, can you please clarify when you say that you don't have an employer to worry about, are you referring to an IRA or you have a Solo 401k plan?

Also, if you have your 401k at Vanguard it can't be truly self-directed, you can't use it to buy real estate with it or invest in a trust deed, can you?

And lastly, if you have a truly self-directed 401k, then you could use your funds for investing personally by utilizing "Participant loan" feature of the plan and you can also invest in real estate, buy a foreclosure, etc. inside of your 401k plan. When you do this - your 401k owns the property, no you personally. 

Hi --

Borrowing against your 401K isn't a bad idea.

Borrowing against your 401K means you are borrowing from yourself. Unlike borrowing from a bank, the interest you pay, you pay to yourself. The amount you borrowed is no longer invested so rather than getting investment gains, your “gain” is the interest you pay back. 

You can borrow up to $50,000 if you have a vested balance of at least $100,000 or 50% of the value, whichever is less. A home down payment is a good use of this type of loan. Using it for a bigger down payment reduces the amount of long-term interest you will pay on your mortgage and can help you avoid PMI.

Under the right conditions, it can be a great decision that can save you money in the long run.

Have a look at Listen Money Matters: a finance blog and podcast. They actually answer this question! 

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