Borrowing from retirement account - worth it in this case?

[Aristippus]

Hope someone is interested in helping me think this through.

My wife and I have a biggish loan in our name which we used to finance our daughter's last year of college (a DirectPLUS loan, for those who are familiar with them). The loan is at 7.9% and we do not qualify for the student loan deduction on our taxes. Our intent is to repay this loan in 3.5 years, and we are on track to do that.

It occurs to me that I could borrow instead against my retirement account, at 1.5% Big savings in interest, obviously, but I'd have to take the money out of my retirement account and pay it back in slowly, over 3.5 years.

The question as to whether or not this is worth it obviously hinges on what the market does for the next 3.5 years, and I don't expect anyone here to be a psychic. But I'm trying to think through whether it's a reasonable idea, and I'm just not sure how to think about it. Anyone want to help?

If it help in considering the dilemma, my retirement account right now is about 70% stock, 30% bonds, and I'm 50 years old.

Thanks in advance!

[bjl584]

The standard advice that you are going to get here is to not pull money from your retirement account. There are penalties, fees, and lost investment opportunity that usually is enough for most people to be against this strategy.

In the longrun it's better to cut spending and boost income to pay back debt than it is to draw money from retirement.

[Aristippus]

Originally Posted by bjl584

The standard advice that you are going to get here is to not pull money from your retirement account. There are penalties, fees, and lost investment opportunity that usually is enough for most people to be against this strategy.

In the longrun it's better to cut spending and boost income to pay back debt than it is to draw money from retirement.

I should have noted that the terms of this borrowing are very generous: no penalties, and a flat $50 loan-origination fee. But it's the lost investment opportunity that concerns me, and I'm not savvy enough to think that through.

[bjl584]

Originally Posted by Aristippus

I should have noted that the terms of this borrowing are very generous: no penalties, and a flat $50 loan-origination fee. But it's the lost investment opportunity that concerns me, and I'm not savvy enough to think that through.

It's hard to think it through and put an exact number on it. But you can make generalizations. If you took out $50K, that's 50K less in your account (for a time anyway) that won't be compounding. 30 years from now that may translate into hundreds of thousands less in your account.

What do the rest of your finances look like?

[YLTL_Dan]

You should take care of your retirement now so your daughter doesn't have to. It's very noble you want to pay for all of her school, but it doesn't help much if she has to support you when you're older. A bit extreme, but just trying to make the point.

[Aristippus]

Originally Posted by YLTL_Dan

You should take care of your retirement now so your daughter doesn't have to. It's very noble you want to pay for all of her school, but it doesn't help much if she has to support you when you're older. A bit extreme, but just trying to make the point.

Well, I'm paying for her school regardless. And it's not as if the money is being taken out of the retirement account permanently; it would be taken out now and replenished steadily over a 3.5-year period, so that it would all be back in by the summer of 2015.

The question in a nutshell, I guess, is whether the money lost because it's been kept out of the market for 3.5 years would be greater than the money paid in interest on a 7.9% loan instead of a 1.5% loan.

I suppose it could be a simple subtraction problem: 7.9-1.5 = 6.4. If I expect a rate of return better than 6.4%, I should keep the money in the market. Is it really that simple? (This is where I betray my total ignorance on these things.)

[bjl584]

Originally Posted by Aristippus

Well, I'm paying for her school regardless. And it's not as if the money is being taken out of the retirement account permanently; it would be taken out now and replenished steadily over a 3.5-year period, so that it would all be back in by the summer of 2015.

The question in a nutshell, I guess, is whether the money lost because it's been kept out of the market for 3.5 years would be greater than the money paid in interest on a 7.9% loan instead of a 1.5% loan.

I suppose it could be a simple subtraction problem: 7.9-1.5 = 6.4. If I expect a rate of return better than 6.4%, I should keep the money in the market. Is it really that simple? (This is where I betray my total ignorance on these things.)

Not quite that simple. You may very well come out ahead by pulling the money out, paying off the loan, and putting the money back. Who knows what the market will do. Furthermore, I don't know what your money is invested in, so it depends a lot on the performance of your individual equities and funds.

Too many what ifs for me. If I weren't struggling to pay my bills, then I would do the sure thing. I'd cut back on expenses and boost my income maybe through some part time work. That is a sure way to pay back debt without having to wonder if pulling money from retirement was a good idea.

[photo]

Originally Posted by bjl584

Not quite that simple. You may very well come out ahead by pulling the money out, paying off the loan, and putting the money back. Who knows what the market will do.

That's really the problem. Although the interest is high on the loan, I'm not sure I would touch the retirement without more insurance that it will be worth it. This is probably a situation where only hindsight will reveal which was the more prudent choice. In lieu of that, I'd leave the 401(k) alone.

[Petunia 100]

Aristippus, you're right, it boils down to which will perform better in the next 3.5 years, your investments or your loan? There is no way to know for certain.

Would you be able to continue contributing while the loan is being paid?

How secure is your job? In the event you leave your job for any reason, the balance of the loan is due and payable or it counts as an early distribution.

Borrowing money at 1.5% is preferable to borrowing money at 7.9%. But the possibility of separation from your employer is something which should be evaluated carefully.

[Aristippus]

Originally Posted by Petunia 100

Aristippus, you're right, it boils down to which will perform better in the next 3.5 years, your investments or your loan? There is no way to know for certain.

Would you be able to continue contributing while the loan is being paid?

How secure is your job? In the event you leave your job for any reason, the balance of the loan is due and payable or it counts as an early distribution.

Borrowing money at 1.5% is preferable to borrowing money at 7.9%. But the possibility of separation from your employer is something which should be evaluated carefully.

Taking the loan won't have any effect on my contributions, and my job is completely secure. But I'm starting to get the sense that this probably isn't worth the gamble.

Thanks for the input, one and all!

[BuckyBadger]

It's not just the difference over the next three and a half years though, right? The money that that money earns in the next three and a half years will be compounding for the next thirty years. And because of the limits on retirement contributions, that money can never be replaced.