From: masimo@netcom.com (Michael Maas)
Subject: Re: Car Loan
Organization: Netcom - Online Communication Services (408 241-9760 guest)
Date: Fri, 2 Oct 1992 21:05:53 GMT

In article <8190125@hpfcso.FC.HP.COM> sjb@hpfcso.FC.HP.COM (Stuart Bobb) writes:
>
>We're getting rather far afield of car loans, but I'm wondering about
>two points about 401Ks that have been raised:
>
>> From: gerryk@ulysses.East.Sun.COM (Gerry Krajenka)
>> 
>> I took out a 401K loan for bill consolidate and this is how it went for me...
>> 
>> 
>> you can borrow half of your money at a time  -- one loan at a time...
>> if you loss your job you can take the rest of your money and pay off the government..
>> you pay yourself back at 8% interest...
>> you pay off the loan with,  before tax dollars....
>
>> Gerry
>
>Are you 100% sure about this?  I am under the impression that my own 401K
>loan is being repaid with _after_ tax dollars.  I'll check again, but I
>would be curious as to how certain you are of the your statement that the
>loan is being repaid with "before tax" dollars.
 
You are correct, the payback is made with after tax dollars.

>> From: masimo@netcom.com (Michael Maas)
>
>> 
>> This could be considered an exception.  If you borrow from your 401k, the plan
>> will require you to pay market interest on the borrowed money.  The interest
>> you pay though goes right back into your 401k. So you are both using the money
>> and investing it at the same time in this situation.
>
>> Mike
>
>Agreed, but as I understand it you are paying that interest with _after_ tax
>dollars (just as you would with any other loan).  When you withdraw, at 59
>1/2 (or whatever legal age) you will pay taxes on everything in the account,
>right?
>
>Thus it seems to me that you will have been taxed _twice_ on some small part
>of the money in the account since you can no longer deduct the interest on
>the 401K loan.  You aren't really being taxed twice on the principal of the
>loan since you are simply "returning" money that had previously been part of
>the pot that is enjoying delayed taxation.
>
>Can somebody help me out here?  I think the following is true:
>
>If I borrow a $100 from the bank or a $100 from my 401K and paid _no_
>interest on either loan, but just paid back principal, at the end of time I
>will have paid the same amount of taxes, either way.
>
>But, I will pay taxes twice on the money I earned to pay the interest on that
>$100 401K loan, right?  (Of course, I only pay taxes once on the second order
>interest, that is the interest/cap gains that is earned by the interest!)
>
>Also, has anybody worked through the numbers to see what impact the above (if
>its true) has on your total taxes, assuming various tax rates in the future?
>
>I guess what I'm driving at is that you get a benefit in that the second
>order interest (interest or cap gains on the interest you paid on your 401K)
>is deferred.
>
>But you pay taxes _twice_ on the interest itself, now and in the future.  In
>one scenario, such as being fairly close to withdrawal such that the tax
>deferred earnings on your interest (second order interest) are quite small,
>it might be a disadvantage to take out a 401K loan and pay interest on it.
>
>But maybe this all balances out since by paying interest on a 401K loan, you
>can effectively get more money into your 401K (and thus defer more taxes on
>your growing investment) than somebody else without a loan since your
>contribution maximum is really (MAX + interest on outstanding loans).
>
>My head hurts now ...
>
>Stuart Bobb
>sjb@fc.hp.com

I think your analysis is sound.  Someone else also responded to my post earlier
with what appeared to me to be a sound analysis as well.  Now that I have seen
your post and his, I would amend my position to say that it only makes sense if
you would have had to borrow the money elsewhere anyway. 

In short, it seems to make little if any sense to borrow money from your 401k
simply to reinvest it somewhere else.  IF on the other hand, you need/want to
borrow money for something else, a car, a kitchen remodel or whatever, it still
seems to make sense to pay yourself the interest where that is possible by
borrowing from your 401k.

Mike

Newsgroups: misc.invest