Monday, January 13, 2014

Suze Orman and 401K loans

At Early-Retirement.org we read the following discussion:  Suze Orman & 401K Loans
Suze Orman and 401K loans

Old Yesterday, 11:57 AM
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Suze Orman and 401K loans


Suze is at it again.

Last night she told a viewer not to take out a 401K loan, because they will need to pay it back with after tax money, so they will be paying double taxes. I thought I must have heard her wrong, so I replayed the snippet. Nope, she actually said it. Her argument is that the loan money is being paid with after tax dollars, and somehow she equates that to double taxation.

What she seems to be ignoring is that the money in the fund was deposited pretax. So the money being used to pay it back is no different than paying back a traditional loan with after tax dollars. It has no impact on the taxes that were deferred on the original deposit.

What she also ignores is that the interest on a 401K loan is being paid back to yourself. So in effect, it's a loophole that allows someone to contribute more than $17,500 into a 401K per year, by contributing the entire $17,500 through payroll deposits, and then contributing the interest into the account on top of those funds. And the interest is money you are paying to yourself, not a lending institution.

So if you need to take out a loan and have the funds to do so in your 401K, I think it's a great option. You may run into trouble if you leave the company you are working for and may have to pay it back within 60 days, but otherwise it's a great deal.

As for Suze, I still enjoy watching her show and find it interesting to see the smattering of callers who present their various financial issues. But I was left seriously wondering, doesn't anyone double check what Suze tells these people just to prevent her from embarrassing herself and saying things that are completely ludicrous?
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Old Yesterday, 12:01 PM
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The interest you pay back to yourself is double-taxed, but not the principal.

I think her viewers don't know the difference between interest and principal and a bunch of other financial things.

We used a 401(k) loan to invest. http://www.early-retirement.org/forums/images/smilies/smiley.gif
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Old Yesterday, 12:26 PM
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http://cdn.early-retirement.org/forums/images/early_r/misc/early_r/quote_img.gif Quote:
Originally Posted by LOL! View Post
The interest you pay back to yourself is double-taxed, but not the principal.

I think her viewers don't know the difference between interest and principal and a bunch of other financial things.

We used a 401(k) loan to invest. 
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I still call BS on this logic....

ANY earnings in the 401(k) is going to be taxed.... ANY interest paid on any loan is going to be with money that has been taxed.... combining the two into one transaction does not change anything...


Let me explain the logic...

#1... you borrow money from the bank (not your 401)... you invest your 401 money into bonds.... to make it simple, the interest rates are the same....

You pay interest to the bank from ordinary income (it has been taxed)... eventually you take money out of your 401(k) and have to pay taxes on it... you have to pay taxes on the interest your bonds earned (the important part)...


#2... you borrow money from your 401(k)... your 401(k) 'investment' is the same as a bond, but it is not "YOU, Inc."....

You pay interest to your 401(k) from ordinary income (it has been taxed)... eventually you take money out of your 401(k) and have to pay taxes on it... you have to pay taxes on the interest your "bond" (the loan) earned....


What is the difference between #1 and #2 when it comes to taxeshttp://www.early-retirement.org/sk/forums/images/smilies/confused.gif NOTHING.. the big difference is that the bank will probably charge you more interest than you can earn on investing in bonds... the bad part is that you might not be investing in bonds and would have earned more in the 401(k) if you had not taken out the loan....
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Old Yesterday, 12:43 PM
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The real problem with 401K loans is that any gains that would have occurred to the loaned out money are lost.

Had you taken out loans last year your real penalty would be the interest plus all the big lost gains from last year.
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Old Yesterday, 01:20 PM
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I have told my children their retirement money is just that. It is not for a home loan or any other type of loan. It is not for their SO. It is there for their retirement and if their SO is there to enjoy it with them all the better.

If it takes someone saying something that is not technically correct, but helps them get the message that it is not wise to use retirement funds until retirement, I'm all for it.

I don't think FIRE participants are Suze Orman's audience.
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Old Yesterday, 01:40 PM
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http://cdn.early-retirement.org/forums/images/early_r/misc/early_r/quote_img.gif Quote:
Originally Posted by Texas Proud View Post
I still call BS on this logic....
Good on the BS call. I don't disagree, but let me add some details:

1. The loaned money was invested in a 529 plan, so gains on invested loan were tax-free because they were used to pay college expenses.

2. The loaned money was invested in the same asset class that it was invested in the 401(k), namely a bond fund. HOWEVER, the 401(k) bond fund had an expense ratio of about 2%, while the 529 plan bond fund had an expense ratio of about 0.3%, so just the difference in fees made the loan come out ahead.

3. The interest rate of the loan was higher than the return of the bond funds, so the 401(k) grew larger than it would have because the "loan" performed better than the bond fund AND fewer fees were removed (see 2 above).

Sometimes free money is hard to find, but when someone drops a few thousand dollars on the sidewalk, I pick it up.

More on #1 above: Some folks get a state income tax break for 529 plan contributions, but don't have enough money to fully contribute the max to 401(k) and contribute to 529 plans. Can you think of a way to have your cake and eat it, too?
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Old Yesterday, 02:44 PM
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Originally Posted by MasterBlaster View Post
The real problem with 401K loans is that any gains that would have occurred to the loaned out money are lost.

Had you taken out loans last year your real penalty would be the interest plus all the big lost gains from last year.

I was going to point this out. Imagine taking $100k out of your 401k late in Dec. 2012, say it was in equities, look at what the DJIA, S&P 500 and the NASDAQ returned last year! You pay yourself back at what 4%, 5%, 6%? What a deal! Don't say but if you invested it - it was invested!

I'm glad Texas Proud posted his comments cuz I've seen this in different threads here and elsewhere about how it does not matter and I say it does. You paid back before tax dollars with after tax dollars that when they are taken out in the future will be taxed. So that money was not taxed when it went into the 401k, then it was replaced with money that was taxed just to have it taxed again when you take the distribution. Tell me how that isn't crazy.

These loans are not a good idea and I think they should be abolished.
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Old Yesterday, 03:31 PM
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On the subject of gains, bond funds lost money last year, so if one took a loan from their 401(k) bond fund and paid back at 4% or 5% interest rate, then their 401(k) would have gained over their bond fund in the 401(k).

Anyways, I agree that for many people, a 401(k) loan doesn't make sense, but when it does make sense, why not get one?

Try this:

One borrows $50K from 401(k) and puts it in their checking account. They take that money and use it to make payments on the 401(k) loan. Did that $50K get taxed because it came out of the 401(k)? No. Did it get taxed because it got paid back into the 401(k) as payment for the loan principal? No. Did it get double-taxed? No.
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Old Yesterday, 08:43 PM
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so here's what I did. The interest on my house loan was not deductible as the standard deduction was larger than the sum of all of my deductions. I owed about $7k in interest for the remainder of the loan, I think it was about 5 years. I took a 401-k loan to pay off the house, and targeted my BOND allocation, and borrowed from that portion of money, leaving the Stock allocation intact. I paid off the mortgage (if you've never experienced it, you couldn't understand the feelings that go with THAT move), and repaid myself via paycheck deductions. The only risk I took was a loss of job, and then the risk was merely a tax issue.

Since I retained the interest that would have gone to the bank, and since I retained the stock allocation, I think I made a great move. Not for everyone, but when the bonds funds were paying less than 2%, I was earning 6, and netted a nice increase.
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Old Yesterday, 09:03 PM
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http://cdn.early-retirement.org/forums/images/early_r/misc/early_r/quote_img.gif Quote:
Originally Posted by LOL! View Post
Good on the BS call. I don't disagree, but let me add some details:

1. The loaned money was invested in a 529 plan, so gains on invested loan were tax-free because they were used to pay college expenses.

2. The loaned money was invested in the same asset class that it was invested in the 401(k), namely a bond fund. HOWEVER, the 401(k) bond fund had an expense ratio of about 2%, while the 529 plan bond fund had an expense ratio of about 0.3%, so just the difference in fees made the loan come out ahead.

3. The interest rate of the loan was higher than the return of the bond funds, so the 401(k) grew larger than it would have because the "loan" performed better than the bond fund AND fewer fees were removed (see 2 above).

Sometimes free money is hard to find, but when someone drops a few thousand dollars on the sidewalk, I pick it up.

More on #1 above: Some folks get a state income tax break for 529 plan contributions, but don't have enough money to fully contribute the max to 401(k) and contribute to 529 plans. Can you think of a way to have your cake and eat it, too?

You added a third component to the equation.... and if I follow you, you invested the loaned money in the 529 which had a higher interest rate than the 401(k)... good job!! However, it does not change the two examples that I gave... you just added when the loaned money went and it was a good place...

BTW, I would not have borrowed money from the bank to put into a 529 plan as the loan interest would likely have been higher than the bond fund interest, or a negative net yield...
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Old Yesterday, 09:05 PM
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http://cdn.early-retirement.org/forums/images/early_r/misc/early_r/quote_img.gif Quote:
Originally Posted by veremchuka View Post
I was going to point this out. Imagine taking $100k out of your 401k late in Dec. 2012, say it was in equities, look at what the DJIA, S&P 500 and the NASDAQ returned last year! You pay yourself back at what 4%, 5%, 6%? What a deal! Don't say but if you invested it - it was invested!

I'm glad Texas Proud posted his comments cuz I've seen this in different threads here and elsewhere about how it does not matter and I say it does. You paid back before tax dollars with after tax dollars that when they are taken out in the future will be taxed. So that money was not taxed when it went into the 401k, then it was replaced with money that was taxed just to have it taxed again when you take the distribution. Tell me how that isn't crazy.

These loans are not a good idea and I think they should be abolished.

I agree with you in that a loan from stock investments are not the same.... but if it is bonds... then my above example is still correct...


Also, you cherry pick on your timing.... say they took out the loan at the beginning of 2008 and paid if off in early 2009.... then they looked like a genius.... I still would not take a loan out of a stock fund...
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Old Yesterday, 09:11 PM
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http://cdn.early-retirement.org/forums/images/early_r/misc/early_r/quote_img.gif Quote:
Originally Posted by veremchuka View Post
I was going to point this out. Imagine taking $100k out of your 401k late in Dec. 2012, say it was in equities, look at what the DJIA, S&P 500 and the NASDAQ returned last year! You pay yourself back at what 4%, 5%, 6%? What a deal! Don't say but if you invested it - it was invested!

I'm glad Texas Proud posted his comments cuz I've seen this in different threads here and elsewhere about how it does not matter and I say it does. You paid back before tax dollars with after tax dollars that when they are taken out in the future will be taxed. So that money was not taxed when it went into the 401k, then it was replaced with money that was taxed just to have it taxed again when you take the distribution. Tell me how that isn't crazy.

These loans are not a good idea and I think they should be abolished.

I think you are reading my post incorrectly.... I am saying that if you take the loan from a bond fund.... it probably does not matter... and in fact may be better than the bond fund... if the loan has a higher interest rate than the bond fund, your 401(k) has more money after you pay off your loan than it would if you had kept it in the bond fund...


If you took the loan from equities, then all bets are off... you cannot tell if it was a good move or bad move until it is too late... as I said in a couple of posts ago... it done in 2008 it was a great move.... in 2012, not so much...

I might take money out if I had it in a bond fund.... I never would take it out of equities.... but, I have enough money elsewhere that I will never have to make this decision....
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2 comments:

  1. Whenever the stock market appears unstable, every person will pull their cash out. This will end up leaving you with less cash. You have to keep your investments in the market even during bad times.

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  2. Right on. It's more informative and easy to understand. Thanks a lot such a nice guideline.Florida Mortgage Lenders

    ReplyDelete