Login
Financial Independence

Savings rate, FI number, and the path to freedom.

Retirement Strategies

Withdrawal plans, Roth ladders, and early access.

Investing

Index funds, asset allocation, and real estate.

Tax Strategies

Roth conversions, capital gains, and FI tax planning.

Earning More

Career growth, side hustles, and entrepreneurship.

Money Mindset

Beliefs, purpose, and financial psychology.

Health & Fitness

Exercise, nutrition, and mental wellness.

When do retirement loans make sense?

When do retirement loans make sense?

cheryl
cheryl 35 XP · · 8 replies

When does it make sense to use a 401k loan to pay off debt? When does it make sense to withdraw Roth IRA contributions to pay off debt? Is it just a factor of whether the interest on your debt is higher or lower than the interest earned from retirement investments? Are there other implications I'm missing?

Share
Share on Facebook
Share on X
Share on Reddit
Share via Email
Copy link

Replies (8)

David Smith

David Smith

117 XP

1 year ago

I looked at the details of my former employer's 401k loan program years ago. There was a 75 dollar origination fee..... bad start. And upon termination or separation the full loan balance was due in a short period of time. There are simply too many negatives. I have never heard a good case for them.

Simply allocate more of your next and future paycheck to your debt payoff. Lower your 401k contributions to the minimum to get the full match. As the debt goes away up your 401k contribution again. Much more simple and no fees.

cheryl

cheryl

35 XP

1 year ago

Agreed. This is the plan for me!

Roberto Sánchez

Roberto Sánchez

3,299 XP

1 year ago

You need to remember that in most (maybe all?) cases you cannot contribute to a 401(k) which has an outstanding loan. The loan must be repayed before new contributions can resume. And you have a time limit to repay before you are hit with an early withdrawal penalty. Also, you withdraw money which will be taxed, and you repay the loan with after tax dollars (so you lose the tax benefit of the tax deduction on the original contribution).

Let's take an example. Suppose you are in the 20% tax bracket and you withdraw $1000 from the 401(k). You will have to pay the 20% tax (when you next file your taxes), and then you end up with $800. Assuming you pay back the money within the time limit (I'm not sure what the official limit is, but you can probably find that info online), you will have had to put in $1000. To have $1000 you can put in, you will have to have earned $1200. If you are in a position where you will have enough gross earnings within the time window (before the additional penalty hits) that it will amount to 50% more than you took out at the start, you are almost certainly better off not taking the loan.

So, the 401(k) loan is something to maybe use in the scenario where the option is something like your family ends up destitute and on the street. And probably not any other reason, IMHO. If at all possible, you are way better off just pausing all retirement contributions and savings and just putting as much as you can to pay down the debt as quickly as possible. Unless the debt has an astronomically high interest rate, that will be the mathematically and psychologically superior solution practically every possible scenario.

There is also the opportunity cost of the contributions being out of the account.

For the Roth IRA, that's a much different scenario. You've already paid the taxes, so there is no tax to pay. And there is no penalty if the account has been opened for more than 5 years (assuming it is a genuine contribution and not a roll-over or conversion, in which case it is 5 years from the date of roll-over or conversion). There is also no repayment option. Once the money is out of the Roth IRA, it is out for good. So the only consideration is the opportunity of that money no longer being able to grow tax free. Like with the 401(k), I would avoid pulling the money out of a Roth IRA for debt repayment. That math is less bad than for the 401(k), but it still isn't good.

brub888

brub888

828 XP

8 months ago

Alas your first statement "in most (maybe all?) cases you cannot contribute to a 401(k) which has an outstanding loan" is a false premise. Where is your evidence?

I do not have specific data but I did ask multiple LLMs and they all replied: In most cases, yes, you can continue to contribute to your 401(k) while you have an outstanding loan. While the IRS allows simultaneous contributions and loan repayments, individual employers are allowed to set their own rules.

Although LLMs are known to hallucinate, I have more confidence in their answer than yours.

Jarrett Sebo

Jarrett Sebo

352 XP

1 year ago

I didn’t realize there were some plans like this. My loans are very flexible, I can still contribute on top of the loan and it can be paid off in periods up to like 5 years.

Roberto Sánchez

Roberto Sánchez

3,299 XP

1 year ago

Even if that is the case, you still take out pre-tax dollars (which you will be taxed on), and you must replenish with after-tax dollars. That generally makes the math absolutely terrible, even if you otherwise have a lot of flexibility around the arrangements.

Jarrett Sebo

Jarrett Sebo

352 XP

1 year ago

Thanks for the reply! I never considered the fact that my loan I took (when I knew less than I do now) was being paid back after tax, this seems obvious now that I’ve considered it. I already knew they were generally a bad idea, but this adds a layer.

cheryl

cheryl

35 XP

1 year ago

Thank you SO much for explaining all that detail. It makes it very clearly a poor choice. I have both traditional 401(k) and Roth 401(k) contributions. I haven't checked to see if there is a possibility to take out a loan specifically from Roth 401(k) portions, but that scenario seems like it would bypass all the tax consequences that come with the traditional 401(k) loan. That option probably does not exist since it sounds too good to be true. Take out money that has already been taxed, repay it with money that has been taxed. Miss out on 401(k) contributions during the loan period, but if I'm trying to get out of debt then I probably shouldn't contribute much to retirement anyway. In any case, this is just a thought exercise at this point. I'm convinced that I should just leave my retirement accounts alone. Thanks!

Showing 2 of 8 replies

View all replies on Community

Comments

Your comment will be posted after signing in
Join the Conversation

Create an account or sign in to post a comment.

Debt Guide
How to Pay Off Debt: A Step-by-Step Framework

Read our complete guide to get up to speed.

From a Recent FI Weekly
“If you’re at Fidelity investing $500/month into a Vanguard mutual fund, you might be losing almost 10% of every contribution before it’s even invested.”

Plus more counterintuitive insights, real stories, and actionable strategies — every Tuesday.

Join 87,000+ people. Free. Unsubscribe anytime.

Track Your Progress to Financial Independence

Get your personalized FI number and track how close you are to reaching your milestones. Most members are closer than they think.

Personalized FI number calculation

Track progress to Coast FI & full FI

Live dashboard updates as you hit milestones

or

100% free — no credit card required

Account created! Redirecting...

Try searching for

⌘K to open anytime

Where Are You on the Path to FI?

1/3

Step 1 of 3

Which of these sounds most like you?

Scan to get the app

Point your phone camera at the QR code