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Does a 401K loan make sense if we have more money than is anticipated to be needed in it?

I'm 32yrs old with a great career and stable earning potential for years to come. I have a 6 month emergency fund, $10K saved up for a car purchase, $10K in a Roth, and $130K in my 401K. I can borrow up to $50K. I currently owe $150K on my condo, and its worth about $100K. Should I consider a 401K if I can refinance w/ the loan amount? There's also an opportunity to buy a nearby condo property for $60K as an investment property. Would a 401K loan make sense to make an all-cash payment to buy the nearby investment property? Note that I'm cash-flow positive in my budget, but since my job earnings are stable, they are unlikely to go up or down significantly in the years to come (think <3% raises). Thanks

Mar 20, 2013 by Joseph in  |  Flag
7 Answers  |  8 Followers
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4 votes

Joseph, I gotta go with Marcus on this one. After 18 years of working with people building wealth and experiencing the results of their efforts, here is what I've learned.

"Wow. I'm really glad I bought that condo for an investment! The developer told me EVERYTHING that was wrong with it. The condo fees never went up, and the repairs were never costly or inconvenient. The renters ALWAYS paid on time And I saved so much on my taxes. And when I sold it - I made as much as I thought I would and the taxes weren't that much." SAID NO ONE EVER. AND I DO MEAN EVER. Not ONCE in dealing with thousands of clients have I ever ever and I mean EVER heard someone tell me how great an investment a condo turned out to be. Yes, occasionally they made money... but... not so much and the hassle factor was usually painful. The people who tell you how great condo investments are usually are either in the real estate field (and have people who do all their work for discounted prices) or have a condo to sell YOU so they can get out of it.

And I have also learned:

"Hey - I'm ready to retire and I just am really ticked off at myself that I have all this money in my 401k. I mean... who needs 2 million tax-deferred, employer-matched dollars in my nest egg?? Boy, I really wish I'd bought that condo so I could have a "project" to work on and fix up and go to condo committee meetings and fix stuff and deal with the hassle of the "condo mafia" that keeps telling me my paint is peeling or my windows have steamed up and I need them replaced. And now I could SELL it for a profit... but since I've depreciated it the tax bite is painfully high..."

Trust me on this one. I've seen it way too many times.

Now I do like the idea of trying to refinance your own condo. If you need a loan from your 401k and you have the cash flow to 1) pay yourself a decent interest rate and 2) keep funding your 401k at the same level you are now... then it might be a good idea. But you should do an opportunity cost/present value comparison (with tax-equivalent yield) to see the difference. If you don't know how to do that yourself, seek help with a fee-only financial advisor and they can help you figure it out. Or a CPA too.

Good job on a strong 401k. If your 401k has a Roth feature, I would look into that too.

Jon Castle http://www.WealthGuards.com

2 Comments   |  Flag   |  Mar 21, 2013 from Jacksonville, FL

Thanks Jon. Perhaps you are right - it gets down to the nitty gritty and it would be best to consult a CPA or fee-only CFP. I will be doing that perhaps in the future.

It basically comes down to 3 buckets - short-term, middle- and long-term. My short-term and long-term buckets are in great shape. Its my middle-term bucket that is essentially empty, and appears will be so for quite a while. I'm wondering if there becomes a point at which I have too much in my long-term and not enough in my middle-term. That's the part I'm looking to improve, and I figure with low-interest rates now and for a little while longer, its something I should consider.

Thank you very much Jon.

Flag |  Mar 21, 2013

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Flag |  Dec 16, 2019

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3 votes

Joseph - You've provided a lot of good information here but I would be curious to know why you think you have more money in your 401k than you anticipate needing? Based on what you have described here you are definitely on the right track in saving for a successful retirement, but before you go off and even consider using your 401k as an "investment vehicle" for other ventures I would suggest you have a clear understanding of what you need to save for retirement (i.e., a retirement plan).

3 Comments   |  Flag   |  Mar 21, 2013 from Long Beach, CA

Thanks Marcus. I am on the right track... and perhaps I don't have as much as I believe. I do have a (very small) pension, but I don't count that these days. As for your advice, that makes sense. Another responder mentioned trying to get a lower interest rate on my mortgage, which is what I'm hoping to do.

It basically comes down to 3 buckets - short-term, middle- and long-term. My short-term and long-term buckets are in great shape. Its my middle-term bucket that is essentially empty, and appears will be so for quite a while. I'm wondering if there becomes a point at which I have too much in my long-term and not enough in my middle-term. It sometimes feels like it.

Thanks for your advice.

Flag |  Mar 21, 2013
Marcus Brendan Crawshaw

Joseph - I assume your "middle-term" bucket is money you would like to have access to prior to age 59 1/2. In that regard, I would encourage you to look at your capability to fund regular taxable account(s) without borrowing from your other assets. This could be your condo idea, a general brokerage account to invest in the stock market, etc. The question you originally asked is very subjective so working with someone to hash out what works best for you based on your personal situation would probably be a good move. You really need to understand all your options.

Flag |  Mar 22, 2013 near Long Beach, CA

Thanks Marcus - that's exactly what I mean by Middle term. I also have a small pension that is still being funded, so when I account for all that, assume no social security, my retirement plan projections (based on the ING service my company uses) show I'll be all set for retirement. Its the middle-bucket that has me curious if I'm doing the right thing... and you're right - it may be a very unique position. Thanks for your assistance.

Flag |  Mar 22, 2013

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3 votes
Jason Hull Level 20

Hi Joseph--

I think that you're framing the question in terms of current needs, e.g., you have more money in your 401k than you need right now and are wondering if you can get a higher return on the money with some other form of investment (paying off your mortgage and buying an investment condo) rather than sticking with what you have.

The biggest risk of a 401k loan, to me, is having it called if you leave the company where you're presently working or you don't make a payment in 90 days. If that happens, you're hit with a 10% penalty and ordinary income taxes; furthermore, you won't have the liquidity to pay back the loan being called.

The other issue is that you're using after-tax money to repay the loan when you've made a pre-tax contribution previously. So, you'll wind up being taxed twice on that money (once to get the money to repay the loan and the second time when you withdraw from the 401k later).

I know it's tempting to get rid of the mortgage and you're thinking that you'll change the debtholder from the bank to yourself, but the risks of getting that loan called in the 5 year payback period is just too high for me personally to feel comfortable with it, and it's not even enough to pay off your current mortgage.

It's also tempting to buy investment property. I own investment properties and wait until I can pay cash with them, even though that's not the mathematically correct strategy due to mortgage interest deductions leading to a higher return on cash invested. There are times when I was SORELY tempted to buy a property with a mortgage because of a GREAT deal, but the reality is that I see GREAT deals probably every other month. Because real estate is so illiquid (relatively speaking) and so irrational, it's, relatively speaking, easier to find deals which make sense from an investment standpoint than it is, in my opinion, to find diamonds in the rough in the stock market.

The other important aspect of rental real estate which I think should encourage you to wait is that you need a significant cash cushion, even if you own the properties free and clear. It seems that there's always some sort of plumbing problem, fence issue, etc. on my rental properties, and while, in totality, they're getting me a good ROI, there are times when I'm writing significant checks several times in a month and then waiting for the rent checks to catch me back up from a cash flow perspective. If you borrow the money from your 401k and kill off your emergency fund to buy the condo, you have no wiggle room (aside from a cash advance on the credit card) if you find yourself having to fork over more money than you expected to do the make-ready to get a renter in there. It's a tightrope walk.

Furthermore, you said that you're cash flow positive in your budget. If you borrow from the 401k, you've just created a new expense which might now make you breakeven or even less than that. If your lender would recast the mortgage, that might work, but if not, can you handle the additional expense? Why not just throw that extra money at the mortgage and kill it off as quickly as you can? Throw bonuses at it and throw your tax refund at it. Then, once you've knocked it off, use the money you were putting into the mortgage to go into your investment property fund? That's what we did.

2 Comments   |  Flag   |  Mar 21, 2013 from Fort Worth, TX

Thanks so much Jason. I appreciate your comments. Your method of just throwing the extra money at my current mortgage, and using cash to buy investment properties, is the more prudent one. Its probably the best advice, honestly - and I think I knew it in the back of my mind - but asking some advisors here is confirming it.

Real Estate is something I see myself involved with in the near future for sure. My parents own a rental property - all paid off - and yes, there are still alot of headaches.

Thanks again Jason, I'll be re-reading your answer a few times to make sure it all sinks in!

Flag |  Mar 21, 2013
Jason Hull

Joseph--Glad to help. One place to look to get smart about investment property is http://www.biggerpockets.com. What I didn't learn from the school of hard knocks, I learned from there.

Flag |  Mar 21, 2013 near Fort Worth, TX

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3 votes
David N. Smith Level 10

From what you have said, I imagine you are trying to get a better interest rate on the $150,000 mortgage on the condo that you say is worth $100,000. I would suggest putting more money into an upside down asset doesn't make sense. You might consider talking with your lender or perhaps an attorney that can help renegotiate your loan. As far as buying the other condo for $60,000 that would be a great idea if you did not already own one. If you want to be in the real estate business that is one thing, but dabbling usually doesn't turn out well.

By the way it sounds like you are doing a good job at saving. Keep it up, slow and steady wins the race.

Good luck. David

1 Comment   |  Flag   |  Mar 21, 2013 from Miami, FL

Good idea... would love to talk with a lender or attorney that would go along with me. I haven't talked with my current lender, but I've talked with other banks, none of whom have shown a willingness to accept my loan. Also, good call on the "dabbling".... I need to be more intentional about it.
Thanks David.

Flag |  Mar 21, 2013

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2 votes

First, I agree with alot of the other comments. However, you are borrowing from yourself and will also pay yourself back with interest, so it all ends up in the same pocket. Review a couple of issues and this will help you make a more informed decision. 1] Get a complete financial plan completed to fully understand what it is you need to prepare for a secure "retirement". 2] When you are investing, fully understand each asset class [real estate/stocks] and where in the investment cycle they currently stand [To/Bottom] to get a better handle on the appropriate entry and exit strategy needed. Hope this helps. Good Luck, Dan

1 Comment   |  Flag   |  Mar 21, 2013 from Asbury Park, NJ

Thanks Danny, I appreciate your comments. You are right that I probably need to understand the investment assets better.

Flag |  Mar 21, 2013

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1 vote

Joseph, first I agree with others that, at $140,000, you don't have nearly enough saved for retirement as you might think you have.

If you borrow from your 401(k), you have to repay in 5 years. Though you currently have a stable income situation, and you certainly know your position better than I, 5 years is a long time, and things can change. I would consider borrowing from your 401(k) to purchase investment real estate to be very aggressive and would not encourage you.

I also would ask you to consider that the money you put away for retirement as a separate bucket of money that you have earmarked for retirement only. As you have positive cash flow, I would save with after-tax dollars, and make your more speculative investments with disposable after-tax dollars. I know real estate is hot now. If you spread yourself too thin and things work out, that is great. But if you spread yourself too thin and things do not work as planned, it is not fun.

Comment   |  Flag   |  Mar 22, 2013 from Delray Beach, FL

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Wow... what a great discussion here. All have good ideas here. However, I suppose I have a little different idea regarding retirement plans. In the past 29 years in this profession, more often than not, I see 401k loans start out as a great idea, but often wind up causing more problems than they solve for those who utilize them.

One particular case I'll throw out is where a client borrowed about 1/4 of his 401k for a down payment to buy an investment real estate property. Everything went well for about two years, until his wife lost her job. There went about 60% of their household income. Then, the job market went south, and he lost his renters for an extended period. Meanwhile, he's having trouble not only making his mortgage, but the payback on his 401k. He went to his HR department to take out another 401k loan to help out with his living expenses, but according to the 401k loan rules where he worked, couldn't do so until his existing loan was paid off... on top of which, his 401k was invested 100% in his company's stock, which lost 40% of its value during the latest "market crash".

The "happy financial ending" (not really) was that his wife got a job through a temp service (not much money, but it helped), and he received an inheritance when his mother passed away. Had it not been for that, he would most likely have lost the rental property, lost his home, and would have filed bankruptcy. I know he'd rather have done that and have his mother back...

This is not the only negative outcome from those who borrowed from their 401k. I only bring this up from having "been there, seen that" over the last 29 years.

And, that, my friends, is why I view retirement plans as just that... somewhat sacred... untouchable... to not be used as a "put and take account", but a "put and keep account" for the day its purpose is most needed... Retirement... and, with any luck, we'll all get there someday...

Comment   |  Flag   |  Apr 19, 2013 from Springfield, MO

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