401k Loan - Bump it up, lump it, or ignore it?

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Topic Author
kjvmartin
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401k Loan - Bump it up, lump it, or ignore it?

Post by kjvmartin »

Greetings - I have searched high & low to find a thread or article with a similar situation to no avail, so I'm looking for some perspective and wisdom.

Loan Type - Residential
Issue Date - 11/14/2013
Estimated Payoff 11/09/2034
Original Principal $11,200.00
Principal Left $10,717.86
Payment Amount $28.32
Interest Rate 3.2500%
Payoff Amount $10,717.86

The total value of your accounts is....... $38,057.04. I'm 30 years old I have no other retirement or taxable investment accounts.
I'm in the 15% tax bracket, married, 1 dependent, 1 income (on purpose).
3% mine + 3% match + 4% government funds go to 401k/457 at minimum.
The 401k/457 has excellent SSGA fund options with extremely low ERs.

This was my 401k loan for a house where the deal eventually fell through. We used the funds to pay off all of our other debt.

The 401k loan allows me to increase my payment (but not decrease it) or make a lump sum payment. No partial payments are accepted.

Question: I can pay this loan off within the next few months, but is this as wise as significantly increasing my contributions and/or starting a 2014 IRA before the deadline?

Thanks

Mike
Last edited by kjvmartin on Mon Mar 02, 2015 10:05 am, edited 1 time in total.
WHL
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by WHL »

Max the 2014 IRA for sure. You'll never be able to access that space again. I would pay off the loan as quickly as possible after that. Actually, you don't mention the balance of your savings account / EF, but I would get that in place becore paying off the 401k loan.
livesoft
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by livesoft »

If the choice is 2014 Roth IRAs for you and your spouse or loan, then the choice is clear: Roth IRAs for both of you.
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Topic Author
kjvmartin
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by kjvmartin »

livesoft wrote:If the choice is 2014 Roth IRAs for you and your spouse or loan, then the choice is clear: Roth IRAs for both of you.
I was hoping you would weigh in - I have read quite a few of your posts and wanted to pick your brain.

If I'm not mistaken, I've read you recommend that the 401k is of the utmost importance and people should only utilize a Roth once you top off your 401k for the year. Is this not the case? I cannot afford to do both, I can only do Roths if I leave the 401k loan in place on a yearly basis going forward. In that case, I could either increase the payment amount or increase my pre-tax contributions a little bit. Tough call for me?
livesoft
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by livesoft »

Are you not already contributing to your 401(k) separately from making loan payments? My spouse had a 401(k) loan and still contributed the max possible along with loan payments.

The Roth IRAs can also serve as backup emergency funds. The contributions could be cashed in without penalty nor taxes in order to help pay off the loan if need be. In essence, almost everyone should borrow money from their 401(k) in order to make Roth IRAs contributions if there is no other way to make Roth contributions and the terms of the loan are inexpensive. Remember: The interest is something going from your left pocket to your right pocket and is not a real expense.
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kjvmartin
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by kjvmartin »

livesoft wrote:Are you not already contributing to your 401(k) separately from making loan payments? My spouse had a 401(k) loan and still contributed the max possible along with loan payments.
I am contributing, but far from maxing. Until I get a plan in place I've just been doing the minimum to get the match. 3%.

My dilemma is do I increase pre-tax contrib to the most I can afford, use those funds for Roths, or use those funds to eliminate the loan?
livesoft
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by livesoft »

In this case, I would use the funds to do the Roth thing because of what I wrote about having to use them potentially to pay off the loan in an emergency.

Tell us about your emergency funds, too. :)
Last edited by livesoft on Mon Mar 02, 2015 10:40 am, edited 1 time in total.
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Toons
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by Toons »

Roth :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee
Topic Author
kjvmartin
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by kjvmartin »

The replies are all appreciated, thank you thank you thank you!!

I keep around 4-5 months of expenses in a high yield savings account, since you asked. It's 8k. We live pretty modestly.

If I were to max 2014 IRAs for both of us, that would mean I would have to use most of and then rebuild the emergency fund.

Our budget allows for $950 in discretionary savings/investing each month. Be it emergency fund, pre-tax, or post tax. ~$138 of that has to go toward my 401k to receive the matching funds. That leaves a comfortable $800 to utilize as we see fit each month.
livesoft
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by livesoft »

You have probably read this, but for completeness in this thread:
http://www.bogleheads.org/wiki/Roth_IRA ... gency_fund
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nedsaid
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by nedsaid »

Keep in mind that if you get laid off, a 401k loan is then deemed paid and you will get stuck with a tax bill that you don't want. Tax plus 10% penalty if you are under age 59 1/2. I am not a big fan of 401k loans for this reason.
A fool and his money are good for business.
triskelion
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by triskelion »

kjvmike wrote: This was my 401k loan for a house where the deal eventually fell through. We used the funds to pay off all of our other debt.
Not to be the wet noodle here, but the loan was originally described as a real estate loan, but then used as a standard loan. I know that RE loans are handled differently than regular loans under the SPD and would be concerned that you have created a distribution. As such I would pay off the loan ASAP.
ERISA Stone
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by ERISA Stone »

triskelion wrote:
kjvmike wrote: This was my 401k loan for a house where the deal eventually fell through. We used the funds to pay off all of our other debt.
Not to be the wet noodle here, but the loan was originally described as a real estate loan, but then used as a standard loan. I know that RE loans are handled differently than regular loans under the SPD and would be concerned that you have created a distribution. As such I would pay off the loan ASAP.
Yeah, I didn't want to add bad news to the thread but if your 401k loan is not for the purchase of a primary residence, the maximum time period is 5 years. I'm not sure who is at fault here - the plan sponsor of the OP - if this gets picked up during an audit, but it might be bad news for someone. I'm not even sure what the correction would be.

Having said that, if your loan paperwork is filled out correctly, the IRS/DOL usually don't dig deeper than that so I'm not sure how they would find out. It would be best not to mention that fact again just to be safe.
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kjvmartin
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by kjvmartin »

It was a situation purchase agreements and mortgage info was signed, sealed, and delivered. The 401k folks only needed a signed purchase agreement to release funds and there were no more questions after that. There were title issues that halted the deal in court for months on end and the wife was getting more and more pregnant. We eventually bailed and were refunded all of our deposit but not our appraisal/inspection fee unfortunately. We ended up moving, during the polar vortex, to a 2 bedroom apartment across the parking lot for $100 more a month.

That was our third attempt at a house. The first house we wanted everything went great and then someone stole all of the copper plumbing prior to closing. Lost an appraisal and inspection fee there as well.

The other house ended up with major massive issues upon inspection including basically needing an entire new furnace and a/c. We lost an appraisal and inspection fee on that when the seller would not negotiate. To be fair, it was under market value, but not that much.

We've spent around $2000 in fees trying to purchase a house the last 2 years and have mostly given up.
ERISA Stone
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by ERISA Stone »

I don't doubt good intentions were there but it doesn't excuse the fact that you received options on the loan in which you weren't eligible. Like I said, I don't know how the situation might be found out, but it's a significant error, IMO. The government is very strict about loan provisions in a retirement plan.
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kjvmartin
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by kjvmartin »

I called them once we knew for sure they house wasn't going to work. They told me at this point it was up to me and I could either repay or keep the money.
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nedsaid
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by nedsaid »

If you have a 401k loan, you want to check with your HR Department. I suppose there are exceptions but the general rule is that your loan will be deemed a distribution when you leave the company.

I have done taxes for years and have seen this happen. Most employers do not want the bother of servicing a loan when they can't deduct the payments from paychecks.

My guess is that there are relatively few plans that would allow a former employee to keep making payments on a 401k loan.

I did find this article from money magazine that addresses this. The expert is Walter Updegrave.

http://money.cnn.com/2002/07/29/pf/expert/ask_expert/
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ERISA Stone
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by ERISA Stone »

I want to be clear in that I there is a small chance this ever gets noticed. First, the plan would have to get audited - 1-1.5% chance, unless your firm does something that increases its audit score. Next, the IRS/DOL would have to focus on loans. Then they would have to choose your loan to audit, etc., etc.

That being said, the IRS is very firm on this that if you didn't use the loan for the purchase of a primary home purchase, the maximum you can take a loan for is 5 years. Generally, if a participant takes longer than the maximum allowed period to pay off a 401k loan, the principal remaining after the period is taxable. I think your company did you a small disservice by allowing you to choose how to move forward, since they, not you, are fiduciaries. Maybe they asked their TPA and this was their recommendation. But in my opinion, you have created a risk, albeit small, by having the potential of now paying taxes on the principal exceeding the 5 year pay off period.

I'm not sure if this type of error is correctable under EPCRS, but IMO, at a minimum, your company should reprocess your amortization schedule to reflect a 5 year period. This would eliminate any risk of owing taxes on the amount exceeding the 5 year period. I'm don't know if this is allowed under the loan policy but IMO, it's a lesser evil than creating taxable income.

Ultimately, your plan sponsor should run it by the TPA to determine how it should be handled. If you have the time, I would suggest running it by the folks at http://www.benefitslink.com. It's the best source on the internet for retirement plan information. They may have a different take.
Topic Author
kjvmartin
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Re: 401k Loan - Bump it up, lump it, or ignore it?

Post by kjvmartin »

I can increase my payment at any time, thereby shortening the term of repayments. I could do the math and get it paid off in 5 years from origination if I wanted, and maybe I will consider that now.

I'd have less to contribute to my new Roth IRA, but peace of mind being in as best compliance with the law as possible.

They really made it seem like not a big deal - I could have actually used the funds for anything at all if I had my own cash on hand to buy the house. For example, if I was buying a property with 20% down and planning to use savings to fund the down payment, I could still request as much as I wanted for a residential loan without verifying how I used it. I asked point blank - because we weren't sure what funds would be used for what costs (we needed appliances and some updates).
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