401k loan for car payoff - bond allocation used

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aadwen
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401k loan for car payoff - bond allocation used

Post by aadwen »

What are your thoughts on taking bonds from 401k, loan to myself to pay 3% car loan off and paying back into 401k?

Wouldn’t this make more sense than using cash? Effectively using the loan to increase my 401k balance?
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StormShadow
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Re: 401k loan for car payoff - bond allocation used

Post by StormShadow »

The self interest you are paying yourself is with after-tax money. You'll pay a second income tax on it when you redeem it at retirement age.

Also, you may lose out on the opportunity cost of not having your money in the stock market. Assuming you buy into the belief of "time in the market" > "timing the market".
Spirit Rider
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Re: 401k loan for car payoff - bond allocation used

Post by Spirit Rider »

Not really unless the loan is from a Roth 401k account. The interest rate on a 401k loan is usually 1% - 2% above the prime rate currently at 5%.

So let's say you would be paying 6%. The difference between your bond return and 6% would effectively be an after-tax contribution to the 401k.

That works fine for a Roth account. You would be increasing your contribution space.

However, if it is a traditional pre-tax account you would receive no basis in that amount and it would be fully subject to ordinary income taxes on withdrawal.

You generally would be better off investing the extra amount in a taxable account in equities and rebalancing as necessary.

This has the same effect as making non-deductable traditional IRA contributions or 401k after-tax contributions when you can not roll them over to a Roth IRA.

Not to mention all the negatives of 401k loans in the first place.

StormShadow: The OP specifically stated that they would effectively use the loan to replace the bond component of their 401k, So there shouldn't be a lost opportunity cost.
Last edited by Spirit Rider on Thu Jul 26, 2018 12:11 am, edited 1 time in total.
TropikThunder
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Re: 401k loan for car payoff - bond allocation used

Post by TropikThunder »

StormShadow wrote: Wed Jul 25, 2018 11:32 pm The self interest you are paying yourself is with after-tax money. You'll pay a second income tax on it when you redeem it at retirement age.
The payments being made on the car loan are after-tax as well, so that's a wash. While it's true that the interest re-paid back into the 401k is taxed upon distribution, the principal is only taxed once (the money borrowed from the 401k is pre-tax, meaning he's paying off the car loan with pre-tax money).
StormShadow wrote: Wed Jul 25, 2018 11:32 pm Also, you may lose out on the opportunity cost of not having your money in the stock market. Assuming you buy into the belief of "time in the market" > "timing the market".
It's in a bond fund now, not the stock market. Little to no lost gains considering it's being used to pay off a 3% loan.

This is not to say the loan is a good idea (as Spirit Rider said there are legitimate negatives to 401k loans) but these particular objections don't pan out.
Spirit Rider
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Re: 401k loan for car payoff - bond allocation used

Post by Spirit Rider »

TropikThunder: That is why I only referred to after-tax on the arbitrage amount. There offsetting pre-tax amount is only the current loan's interest rate.
Topic Author
aadwen
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Re: 401k loan for car payoff - bond allocation used

Post by aadwen »

Interesting insight, thanks everyone.
Nissanzx1
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Re: 401k loan for car payoff - bond allocation used

Post by Nissanzx1 »

Most 401K loans are due when you or your employer terminates employment. Just something to consider in addition to the money not being at play in the market...
tim1999
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Re: 401k loan for car payoff - bond allocation used

Post by tim1999 »

When I took a 401k loan from Fidelity, they took it proportionally out of all funds I had invested in. I could not specify to have it all taken out of the bond fund, for example. OP's plan may have a similar rule. In other words, if your account was 70 percent in Fund A and 30 percent in Fund B, and you borrowed $10000, they took $7000 out of A and $3000 out of B. You couldn't tell them take it all out of B. I suppose you are free to reallocate later, but that's how they took it out.
emoore
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Re: 401k loan for car payoff - bond allocation used

Post by emoore »

Nissanzx1 wrote: Thu Jul 26, 2018 11:29 pm Most 401K loans are due when you or your employer terminates employment. Just something to consider in addition to the money not being at play in the market...
Not anymore. The law has changed.
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StormShadow
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Re: 401k loan for car payoff - bond allocation used

Post by StormShadow »

TropikThunder wrote: Thu Jul 26, 2018 12:07 am
StormShadow wrote: Wed Jul 25, 2018 11:32 pm The self interest you are paying yourself is with after-tax money. You'll pay a second income tax on it when you redeem it at retirement age.
The payments being made on the car loan are after-tax as well, so that's a wash. While it's true that the interest re-paid back into the 401k is taxed upon distribution, the principal is only taxed once (the money borrowed from the 401k is pre-tax, meaning he's paying off the car loan with pre-tax money).
So basically you said exactly what I just said.

Its not a wash because you don't pay income tax on a car payment.
Goal33
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Re: 401k loan for car payoff - bond allocation used

Post by Goal33 »

It’s not worth the trouble either way. Just take a car loan if you need a loan.
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jimb_fromATL
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Re: 401k loan for car payoff - bond allocation used

Post by jimb_fromATL »

aadwen wrote: Wed Jul 25, 2018 11:23 pm What are your thoughts on taking bonds from 401k, loan to myself to pay 3% car loan off and paying back into 401k?

Wouldn’t this make more sense than using cash? Effectively using the loan to increase my 401k balance?
I doubt that the potential advantage is worth the risk, especially if you have enough spare cash to pay off the car loan anyway. Maybe a bigger question should be whether to pay such a low rate car loan off early at all.

It could work IF you have a working crystal ball that can guarantee that your 401(k) will be earning less than the rate you're paying on your car loan. And only IF you can really take it out of a bond fund and put it back there. What's your crystal ball predicting for your bond fund anyway?

As another poster mentioned, you may not be allowed to use just the bond fund. Have you verified that is allowed?

A lot of 401(k) plans (and the TSP) take the money out of your funds in proportion to your current alllocation and pay it back in proportion to your allocation of new contributions. So, without that working crystal ball, more likely than not you'll be payng yourself back at a lower rate than your entire 401(k) allocation would be doing.
emoore wrote: Fri Jul 27, 2018 12:03 am
Nissanzx1 wrote: Thu Jul 26, 2018 11:29 pm Most 401K loans are due when you or your employer terminates employment. Just something to consider in addition to the money not being at play in the market...
Not anymore. The law has changed.
The new law only extends the time from the old 60 days or so until your next tax filing deadline plus any extensions. Not a lot of help for someone who lost their job or quit to start their own business near the end of the year and might not have the money in time. NEWS ARTICLE

jimb
ThePrince
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Re: 401k loan for car payoff - bond allocation used

Post by ThePrince »

aadwen wrote: Wed Jul 25, 2018 11:23 pm What are your thoughts on taking bonds from 401k, loan to myself to pay 3% car loan off and paying back into 401k?

Wouldn’t this make more sense than using cash? Effectively using the loan to increase my 401k balance?
Not a wise move. If you have the cash, pay cash for the car and move on with life.
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grabiner
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Re: 401k loan for car payoff - bond allocation used

Post by grabiner »

jimb_fromATL wrote: Sun Jul 29, 2018 7:22 pm A lot of 401(k) plans (and the TSP) take the money out of your funds in proportion to your current alllocation and pay it back in proportion to your allocation of new contributions. So, without that working crystal ball, more likely than not you'll be payng yourself back at a lower rate than your entire 401(k) allocation would be doing.
However, you can always reallocate. If your 401(k) distributes $6000 from a stock fund and $4000 from a bond fund, you can move $6000 from a bond fund to a stock fund in the 401(k). This allows you to keep the same stock market exposure, so that your lost returns are the returns of the bond fund. (Similarly, as you repay the loan, you can move money from a stock fund back into a bond fund if necessary.)
Wiki David Grabiner
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