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What happens if you default on a loan against your 401k?

Ross Pratt

in Student Loans

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Eric Morgan on April 6, 2018

In a word, no. If you do that you will have a penalty (10%) and will treat the distribution of income (which is taxed at whatever your rate is) But for us taking a 401k whata two years ago was really smart. Me and my wife took out a $5000 loan, 401k, and paid a 14% interest rate car loan. The investment funds is sold to get $5000 are today a value of $4200 (after two years) And the amount that we will save between not having to pay the full coverage insurance and the interest on the car note is quite a bit of money. It worked so well, at the beginning of this year took out another $6000 to pay a 16% interest rate of the SUV loan. The funds are a value of $5500 now and we have saved a little bit of interest and not having to pay for full coverage insurance on that vehicle as well. I took out a third loan to pay off a $6000 credit card for $3500 a savings of $2500 (not to mention that I do not respondent) I am not saying that taking out 401k loans are perfect for everyone. But, we were in a lot of stupid debt. Now we have two cars (and we'll never finance again again !!) and we have paid all of our credit card debt. And the only interest we pay now is to ourselves!!! In reality, before the response provided below is incorrect. I made the incorrect comment below (indented) for the documentation. In reality, the money used to pay off a loan 401k comes in two parts like that any repayment of the loan (principal and interest). The principal paid is not taxed twice. To understand this, you simply have to do the follow-through of the math in their income over the years vs. how much you paid in taxes once you finally withdraw the money. So, in this example, about$ 14,000 is not taxed twice. However, the interest paid on the loan is considered as income for the 401k and this is NEW money going into the 401k. This interest is taxed twice because it is NEW money. You pay after tax dollars but unlike the principal, who does not get to use untaxed dollars to offset this. So, assuming the 25% tax rate that is below, the answer below is only 25% of correct answers. This is a wrong understanding. Only the interest paid on a loan 401k is taxed twice, not the re-payment of principal. To say that the principal paid is paid using after-tax dollars is not correct. Here is a simple example to illustrate: assume you have 50,000$ in the bank, which has been taxed. You then borrow 50,000$ from your 401k. You now have 50,000$ in the bank on which you paid taxes and 50,000$ on which no tax is paid. Now you can change your mind and immediatlely pay off the loan 401k with 50,000$. Hmm... what to 50,000$ taxed or 50,000 free of tax go to pay the loan. Let's see. Before this silly (but legal) sequence of events which had$ 50,000 in money without being taxed on your 401k and 50,000$ of gravel money in the bank. After wards you (oh gee) had 50,000$ money untaxed in your 401k and 50,000$ of gravel money in the bank. How about that... nothing is different. As you can see, there is no change in your tax situation. Director paid to a 401k plan is not taxed twice. I love the ends of the questions. They are so good at clarifying things. If not, think a little bit about you. The author of the below would have us believe that we have used$ 50,000 of gravel money to repay the loan. If we follow that logic, then there is still no difference since from that point of view, they have simply reversed the places of the money, not taxed state. In the end, you still have 50,000$ of money untaxed in one place and$ 50,000 to gravel money in another place. In addition, none of this really matters. A 401k plan is just another money pool with a specific set of rules. The point of taking the money out of a 401k plan is the use of the smart thing that the 401k will. If you receive more of the money you take out to lose, then it is a good move, that is all there is to it. In the evaluation of a loan (OR early WITHDRAWAL) from a 401k plan it is necessary to do two things: 1) do the math to know what it costs you vs. what you do with the money once you get it. You want to know this, even if it is not the determining factor to take the loan (or removal). 2) despite the intangibles in any way. Borrowing from a 401k is usually done for a purpose that cannot be met in another way. Let's consider an example: your daughter wants to go in the field of medicine. Let's suppose that you have two choices, be a Nurse or a Doctor. You have the money to send it to 4 years of nursing school in the bank, but more is needed to make it a doctor. Your 401k plan can provide the additional necessary funds? Do you take the loan? Some people try to figure out the extra money she makes as a Doctor compared to a Nurse in the equation in order to justify. Others would see that in this case the finance are immaterial. The jobs of the Nurse and the Doctor are different and will lead to a completely different life styles for your daughter. That the life you want your daughter to live, the life of a Nurse or of the life of a Doctor? If you want to give it a shot in the that are going to be a Doctor, after taking the loan. What is the cost of the loan may be important, but is secondary to your main objective in this case. Below is the before of the wrong answer. This does not give the complete picture. The loan payments are made with after-tax dollars from your paycheck, but get deposited in the 401k as pre-tax dollars. So when you retire, you pay taxes on all that money again. In the above case, the person who has carried out a total of $14,000. The estimate of interest paid to themselves and we're talking a total of around $18,000. That $18k was already taxed at a conservative rate of 25% by the federal government, state, and local taxes. That means that before taxes of your loan payments is $24,000. That's a $10,000 difference. That is a lot of money "disappeared". Also consider that the $18,000 that this person took as a loan has already been taxed at 25%. When they retire/quit and take your money out of your 401k, they have to pay the 25% BACK on the money. That's another $4,500 (potentially more if you are under the age of 59.5), which is paid to the IRS.

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