Losing Money In Your 401K Through Borrowing
A majority of the population does not need an individual 401k. Even so, some people are convinced that these things are not tax traps and that somehow everything will work out OK.
If you are the type of person who is convinced that their 401k plan is doing good things for you (and will continue to do so), you might as well get the most out of it. You can do that by just leaving it alone. Don't loan money out of it. Don't even think about borrowing from it for any reason.
When you take a loan from a 401(k) plan, you are actually withdrawing money from your account balance and replacing it with an IOU. That IOU will generate interest from your repayments, but it does not generate any extra investment return because the money will only earn interest as and when you replace it.
Most fixed-type investments are debt instruments. They are loans. Examples of this would be T-bills and bonds. In reality, you are lending either the Government or a corporation money in exchange for interest plus your principal after the term of the loan.
When you loan yourself money in a 401(k) though, you are simply replacing the interest you would already be receiving with interest payments from yourself. Remember, you have taken out money from your 401(k), and since it is not in your account while it's on loan, you are not earning interest in the stock, bond, or money market. You've simply substituted one borrower for another or changed the source of interest.
In addition, the interest payments you make back to your 401(k) are with after-tax dollars; and consequently, when you make a final distribution on that money, you will pay tax again on the money you paid back as interest.
Since this happens every time you take a loan against your employer 401k, you are really setting yourself up for a larger tax bite than you otherwise would have been subjected to.
If you are the type of person who is convinced that their 401k plan is doing good things for you (and will continue to do so), you might as well get the most out of it. You can do that by just leaving it alone. Don't loan money out of it. Don't even think about borrowing from it for any reason.
When you take a loan from a 401(k) plan, you are actually withdrawing money from your account balance and replacing it with an IOU. That IOU will generate interest from your repayments, but it does not generate any extra investment return because the money will only earn interest as and when you replace it.
Most fixed-type investments are debt instruments. They are loans. Examples of this would be T-bills and bonds. In reality, you are lending either the Government or a corporation money in exchange for interest plus your principal after the term of the loan.
When you loan yourself money in a 401(k) though, you are simply replacing the interest you would already be receiving with interest payments from yourself. Remember, you have taken out money from your 401(k), and since it is not in your account while it's on loan, you are not earning interest in the stock, bond, or money market. You've simply substituted one borrower for another or changed the source of interest.
In addition, the interest payments you make back to your 401(k) are with after-tax dollars; and consequently, when you make a final distribution on that money, you will pay tax again on the money you paid back as interest.
Since this happens every time you take a loan against your employer 401k, you are really setting yourself up for a larger tax bite than you otherwise would have been subjected to.
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posted by Debt Consolidation Loan at
4:47 PM
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