Financial Planning

[Mr Awe]

My 401(K) plan lets me takes out loans against it, and I have to say paying yourself back at a low APR beats the hell out of paying pretty much anyone else back at a probably higher APR.

The money appears to be cheap to borrow, but there's some additional costs that people don't think of. Often times, the only contributions that can be made are loan repayments. So not only did you take a percentage of your capital out, you're not adding to the balance only bringing yourself back to even. The potential investment return lost often outweighs the low interest on the loan.

Great points. There's also the fact that you take out pre-tax dollars but you have to repay it with dollars that you've paid tax on.

So, say you borrow X dollars. To repay it you have to earn X + Income tax on X. So, you're losing the income tax part. You then have to pay income tax on it again when you withdraw it upon retirement. You pay double the income tax on what you borrow.

Normally you just pay income tax upon the withdrawal during retirement.

Mr Awe

 

[Mr Awe]

^ Thanks for the clarification. My 401K account is through my employer, but I pay the full contribution, meaning my employer doesn't match what I put in every pay period.

On the other hand, since I'm a civil service employee, we have a retirement system funded by working employees. The current contribution rate is currently at 6%, but management is pushing to have it increased progressively to 8.7% within the next few years.

It's usually recommended that if you employer doesn't provide a match for a 401K, you should invest in a Roth IRA. You get more flexibility amongst where to invest, including very low fee investment houses. Also, you get the withdrawal benefits that I described.

401Ks are best when your employer matches and you should invest up to the full match amount.

Mr Awe

 

[Kirby]

Before you take a 401k loan make sure that it doesn't have a due upon termination clause in which if you leave employment (either voluntary or involuntary) that the entire loan amount comes due upon separation from the company. You could end up paying some big penalties if you don't.

 

[Gryffindorian]

This Wikipedia table shows comparisons among different retirement plans.