401(k) loans and why you shouldn't take one
401(k) loans may seem like a great option but in many cases, they can cost you money. In this video, we talk about how these loans work and why they generally aren't the best option for most people.
In addition, we talk about margin loans (or securities loans), and also the deductibility of margin loan interest. Those two videos are linked below.
What are margin loans (or securities loans): https://youtu.be/tpTmrMdFJVM
Margin loan interest tax deductions: https://youtu.be/murYv35drNs
Transcript:
Let's talk about 401k loans and more specifically, why you shouldn't take one. I'm Chris Kaminski, co-founder and partner here at Consilio Wealth, where we specialize in working with tech professionals at Amazon, Microsoft, Meta, and Google.
All right, 401k loans. You can take a maximum of $50,000 or 50%, whatever is lower, via a loan on your 401k plan. You must be an active participant in the plan, so generally speaking, you can't take a loan on a plan at a previous employer, and oftentimes, you can't just roll over funds to a new 401k that you just joined and then immediately loan out that cap of, say, $50,000.
The reason why these loans are not the greatest is because you're actually out of the market. So, the marketing on these loans is that you're earning interest, you're paying interest back to yourself. And that's smart, right? Cause any other interest to say your mortgage or a car loan or a student loan, you don't get to keep that interest. It just goes to the bank. In some cases, a mortgage loan would be deductible. However, with a 401k loan, the marketing from the 401k company says you're paying yourself interest. So isn't this a great deal.
I would suggest no, because you're actually out of the stock market. The interest rates on these loans are variable. They can be anywhere from a couple of percent to seven, eight, nine percent in today's interest rate environment here in 2024, and ultimately, we can't predict which direction markets go.
Therefore, we like to recommend clients stay in the market versus try to time these withdrawals. So, in sum, don't be swayed by the marketing of these that says, you're going to earn your interest back and it feels smart to do, this is generally not a good idea.
A better idea is to take a margin loan or securities loan against your non-retirement account. You can generate a loan up to 50% of the account value. These loans do not take anything out of the market. So, all of your investments are still fully invested. You do pay interest on these loans, also at variable rates in most cases. However, nothing is out of the market. I'll link to another video here about securities loans and margin loans so you can learn about them.
In addition to that, sometimes the interest that you pay on these margin loans is deductible against investment earnings. I'll link to a video here on that too. One last thing on 401k loans. Oftentimes you cannot leave an employer with an outstanding 401k loan. Now, sometimes you can.
This is a provision that some plans are able to get around, but generally speaking, assume or at least make sure that if you are considering leaving an employer, that you either have to have that loan paid back, or you can in fact keep the outstanding loan.
Generally, this is because the 401k company doesn't know how to take money from your bank account, they know how to withhold it from your paycheck to repay the loan. So when you leave the employer, they don't have any way to collect the funds. So generally, a 401k loan is due within, whoa, fly, within 90 days of leaving your employer.
All right, that's all you need to know about 401k loans. Do you still have questions on 401k loans? Reach out if you do.
