401K loan default - Company is making me!

**kork13** · 11-22-2013, 06:45 AM

Unfortunately there's nothing you can do. You should have made sure you understood the terms of your 401k loan before taking it... It's situations like this that cause most everyone to say that 401k loans are a TERRIBLE idea. If you have an open 401k loan, if/when you leave your employer, the 401k administrator can elect to call the loan & require you to pay it in full. It seems that the previous provider was actually kind to you by not requiring you to do so immediately upon your job transfer. The new 401k administrator is completely within its rights to either require you to repay the 401k loan in full, or consider it a taxable (and penalized) withdrawal from your account.

With traditional & Roth IRAs, there is a small allowance ($10k I believe) for first-time homebuyers to withdraw funds from an IRA penalty-free for use as a home downpayment. This exception, however, does not extend to 401k's.

So unfortunately, you're stuck. Unless you can produce the $40k to repay the 401k loan immediately, anything not repaid will be taxed as income AND be hit with the 10% early-withdrawal penalty. There is nothing you can do except pay it back or pay the tax & penalty.

**disneysteve** · 11-22-2013, 06:57 AM

401k loans are horrible products, as you've learned the hard way.

Typically, loans are due immediately if you leave the job. Otherwise they are counted as distributions with the appropriate taxes and penalties assessed. What they are doing is the industry standard. There's nothing you can do about them enforcing the rules that you agreed to when you signed up for the loan. It's a costly lesson to learn.

Don't ever, ever, ever borrow from a 401k again. Nobody ever should with the possible exception of avoiding bankruptcy or foreclosure, and even then it probably isn't a good idea.

**corn18** · 11-22-2013, 07:09 AM

I have a silly question. Scenario:

1. 401k contribution maxed out each year
2. Take a $50k loan against 401k
3. Put the loan proceeds in a savings account
4. Repay the loan from the savings account.

The result is I can put more than $17,500 in the 401k each year equal to the interest I paid minus fees. No risk on losing job or having to pay it back straight away because it's in the bank. I am not paying it back with after tax income (except the interest) I may lose out on some serious growth or may avoid some serious downside. I have no cash option in my 401k, so I wouldn't mind a place to stash some regular old cash.

Based on my math, I can get an extra $5k or so into my 401k over 5 years. Fees would be $135 over the life of the loan for my 401k plan.

Tell me why this is a bad idea. Because I was thinking about this last night. Would appreciate your opinions.

Tom

**MonkeyMama** · 11-22-2013, 07:15 AM

This is one reason why 401k loans are such a bad idea. They generally automatically default when you leave your current employment (unless you can pay it back in full). It is unusual that old employer would let you keep the 401k loan in the first place.

**jay2068** · 11-22-2013, 07:30 AM

Thanks for all the input. I figured this was the case.

The odd thing is they let me take the loan even though I haven't worked there for 3 years!

No more 401k loans for me!

**kork13** · 11-22-2013, 07:54 AM

Originally posted by tomhole View Post

I have a silly question. Scenario:

1. 401k contribution maxed out each year
2. Take a $50k loan against 401k
3. Put the loan proceeds in a savings account
4. Repay the loan from the savings account.

The result is I can put more than $17,500 in the 401k each year equal to the interest I paid minus fees. No risk on losing job or having to pay it back straight away because it's in the bank. I am not paying it back with after tax income (except the interest) I may lose out on some serious growth or may avoid some serious downside. I have no cash option in my 401k, so I wouldn't mind a place to stash some regular old cash.

Based on my math, I can get an extra $5k or so into my 401k over 5 years. Fees would be $135 over the life of the loan for my 401k plan.

Tell me why this is a bad idea. Because I was thinking about this last night. Would appreciate your opinions.

Tom

You don't have access to a money market account or money market mutual fund option in your 401k? That's surprising... Another option besides cash that might be available in your 401k can be ultra-short bonds -- these have durations of 1 year or less, and typically have a very stable value mostly comparable to cash.

To answer your question, the problem with your idea is that you are charged "interest" (normally 2% + Prime rate) in addition to the "principle" money that you need to repay. This interest goes into your 401k having already been taxed once as regular income. Upon withdrawal, all of that interest & all of the growth on that interest is taxed AGAIN as income. So you're subjecting yourself to double-taxation, which effectively cuts 50% (assuming 25% tax rate now & 25% rate later) of your investment gains right off the top. It's a rather poor idea all around...

**MonkeyMama** · 11-22-2013, 08:04 AM

@Tom - What is the point of putting more in 401k? You will not get any tax benefit for those contributions (interest paid on loan). This tax deduction up front is the primary benefit of the 401k. So, your plan misses the whole upside of the 401k. Your plan would create a double taxation situation on the interest (since it would not be tax deductible now and will also be taxed again when you withdraw). In fact, investment tax rates are more favorable than 401k withdrawal tax rates, so you are just lining up to pay a lot more taxes all around.

With ROTH 401ks becoming more common, this might not be a bad strategy for a ROTH 401k. The ROTH 401k would ideally never be taxed again. On the flip side, I think you'd lose too much growth while taking out the loan to make this a useful plan. We like to bulk up on our ROTHs and invest them aggressively precisely because all those returns are tax-free. I think cash is an important part of asset allocation, but probably doesn't belong in a ROTH.

401K loan default - Company is making me!