Why 401(k) Loans Can be a Smart Move

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Never thought I would ever say it's a good idea to a take a 401k loan, but you have an interesting point and the next time somebody ask me, I'm going to have to ponder their situation a bit more than to say flat out no.

Charles of CA 11:35AM January 31, 2011

Double tax: No. When you pay interest on your credit card debt, can you deduct it? Nope. So, the only reason you avoid "double tax" in using that debt is that you don't get the money at a future date? I think I would rather get the money and pay the tax than enrich the bank with 18% - 29.9% interest rates.
If you are still concerned, try these options:
(1) Encourage your employer to adopt a residence loan program where they file a mortgage and issue a 1098, so your interest is tax deductible on the way in, and/or
(2) Borrow Roth 401(k) assets, the contributions in, whether regular contributions or interest on a loan, are tax free when they come out.
Opportunity Cost: No, at least not for many who must use the 401(k) because they may not have access to assets from other low cost sources. The opportunity cost is minimal. To get an opportunity cost, you take the difference in earnings between actual investment performance and the interest rate you paid yourself. So, lets use your 12% double digit return and assume it is all a loss. If your alternative was an 18% interest rate from a credit card, and you paid yourself 6%, you saved 12% on those monies - easily offsetting the investment loss. And, of course, the 6% interest is now in your account. And, who among us can consistently achieve a 12% investment return.
The American Payroll Association's annual survey showed 71% of workers admitted that even a one week delay in their paycheck would cause a financial hardship - that about 3/4ths of American workers live paycheck to paycheck. Fortunately, a majority of those same individuals confirmed they were saving in their employer's 401(k) plan, where one was offered.
All to the point, we need people to save more than they feel they can afford to earmark for retirement, and then, we need to be sure that they have ready access to those monies in the form of loans (not hardship withdrawals) where the repayment processes leverage 21st century technology (electronic banking/ACH) so that we are assured that the loan is repaid as often as possible, including repaid should employment end involuntarily without much notice.

Jack of OH 3:54PM January 29, 2011

The double tax myth about 401(k) plans is mathematically not true. It's true you pay off loans with after tax money and pay taxes on withdrawal. But the initial deposits were all pre-tax, and you pay no tax on the money you borrow. The amount getting taxed zero times is equal to the amount being taxed twice, and the effect is the exact same as getting taxed once on all of your income - the same as if you did not take the loan.
It's true that you can miss out on investment gains when you borrow from a 401(k). But this cuts both ways - if you borrow during a market decline (think 2008 and early 2009), your loan balance may be the best investment in your account.
The most important aspect that was left out of the article is that you should not stop your contributions to a 401(k), or allow your loan payments to replace your regular salary deferrals. If you are putting $100 per paycheck into the plan and you take a loan - keep putting in $100 plus the loan payment. Stopping deferrals while making loian payments is a way employees lose out on a lot of potential earnings in the 401(k).

Cliff Woodhall of TX 1:53PM January 26, 2011

There are a couple point missing. Interest is double taxed on a 401(k) loan. You pay your loan back with after tax dollars and then when you take a distribution you are taxed again. Also, what if he missed out on double digit returns, lost opportunity costs can be huge.

Pat of WI 1:24PM January 26, 2011