Should I Pull Money Out of My 401(k) to Pay Off Debt?

This is good but he misses one point. I’m not sure if it’s true of all 401(k) plans but interest on a 401(k) loan usually is paid into the 401(k) account. In other words, the interest is your money. It’s as if you borrowed from the Bank of You. Also, some companies do allow contributions while paying back a loan.

I agree with everything else he says.

6 thoughts on “Should I Pull Money Out of My 401(k) to Pay Off Debt?”

  1. I think you pay income taxes on your loan payments though. So you are trading untaxed 401k money for taxed 401k money (which will be taxed again when you retire/withdraw).

    As usual, it is the tax implications that muddy the waters…

  2. No, you shouldn’t unless it’s absolutely necessary. Like BG says, it will be taxed, and you should really not try to touch your 401k until retirement. I guess it all depends on your situation.

  3. If I understand correctly, you guys mean that you are repaying the 401K loan with after-tax earnings, thereby negating the favorable tax treatment you originally received on the 401K contribution, plus you will be taxed on those same dollars when you withdraw those funds for retirement.

    Did I get that right…. cause that is confusing as all get out.

  4. Miguel) Yes it is confusing! Though I believe I was wrong in #1. The principal part of the 401k loan payment isn’t double taxed, but the interest portion is.

    It is confusing because when you borrow $10k from your 401k, that cash you have in hand represents $10k UN-TAXED. If you were to withdraw the same amount from your savings account, that $10k really cost you $12,800 (pretax to save — assuming the 28% marginal tax bracket).

    If you change your about the loan, you can immediately pay it back with the original $10k you took out. However, if you spent the original money (like it was after tax money), it is going to cost you $12,800 in pretax earnings to generate the original $10k you spent after the loan).

    The mind trick is that the 401k loan amount represents cash that has never been taxed, so has much less purchasing power compared to after tax money (you realize this when you pay taxes and the loan contributions).

  5. My last sentence above should have said:

    …(you realize this when you pay income taxes on the 401k loan repayments).

  6. BG – ok I think I got it now. Good info. The principal on the 401k loan is not taxed and it comes from dollars you earned that were never taxed. So long as you repay the loan (instead of it converting to a withdrawal) you preserve the tax benefits on that $10k principal amount. However, you also pay “interest” to yourself on the loan, which goes into the 401k account. Those dollars are coming from after-tax earnings. But, I would think that if you kept careful records, you would not be taxed again on the interest when you make retirement withdrawals. At any rate, I would think the interest amount is fairly negligible compared to the benefit of having access to your funds, downside being that’s $$$ no longer invested in the market.

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