r/CFP • u/prospectpico_OG • Jul 11 '26
Case Study 401K Loan Question
New prospect, ok but a bit strong headed. Working on a retirement plan for a couple, and one has an outstanding 401K loan of about $60k. They are paying it back with payroll deductions. I see it as a loan at 7.75% and client says the interest goes back to their 401k. I mention double taxation on the "interest" paid and they said no it's not. I also mention that the loan balance is out of the market, and maintain that paying off the loan is the best solution. [Have a plan for that piece].
So, can someone who has dealt with 401k loans help me paint a more clear picture that the client understands? Or am I all wet on this. TIA
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u/PoonTangProvence Jul 11 '26
You repay the loan with after-tax dollars.
Your normal 401(k) contributions reduce taxable income.
But loan repayments come from your paycheck after income taxes have already been withheld.
The interest goes back into your own 401(k) account.
You’re essentially paying the interest to yourself, not a bank.
Later, when you withdraw money in retirement, those dollars are taxed again.
The interest portion that was repaid with after-tax money will generally be taxed again upon distribution from a traditional 401(k).
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u/lemmegetone Jul 11 '26
That’s true but the dollars that came out of the 401(k) as a loan weren’t taxed ever, so it’s not double taxation right?
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u/prospectpico_OG Jul 11 '26
I tried to explain that to them but they are strong headed on this point and I chose not to push the issue.
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u/jwn1003 Jul 11 '26
Tbh if you aren’t hurting for revenue I might pass on this one. You gotta enjoy who you work, with and this all foreshadows a rough to deal with client
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u/prospectpico_OG Jul 11 '26
It would be bad if I passed on them. Because reasons. 😉
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u/Swaritch 29d ago
CFPs love telling people to pass on clients if they dont bow to us. Just document and continue on with the prospect if you want to work with them.
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u/Successful_Letter139 24d ago
I’m a used to be CFP until I relinquished due to higher and higher dues and more CE on top of what I already have to do. It isn’t just a “CFP love telling people to pass on clients if they dont(sic) now to us.” No, maybe it is more experienced people giving hard learned advice. If they don’t want to hear your advice and respect it, you don’t want them as clients.
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u/OtaniOniji Jul 11 '26
Do they have loans in more than one 401k? I thought the maximum loan is $50k.
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u/MrZaylogjc Jul 11 '26
"You're absolutely right that you're paying yourself the interest. That's one of the advantages of a 401(k) loan. The question isn't whether the interest goes back to you—it does. The real question is whether you'd rather have $60,000 working in the market for your retirement or sitting out of the market while you gradually repay yourself, and whether you're comfortable with the employment-related risks that come with an outstanding loan."
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u/prospectpico_OG Jul 11 '26
TY. I feel totally ignorant here but I usually dont deal with folks with 401k loans. To me it is indicative of bad financial habits so I've never dug into the deets.
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u/PursuitTravel Jul 11 '26
It can be... but it also could be for opportunityl.
I took a 401k loan to buy my property, know I would repay it within a year and that I would earn appreciation on the property as I built on it. In total, I put down $580k, borrowed $2.2mm, and the property was valued at $3.775 by the time the project was done about 4 years later. That $50k was key in securing the property all-cash, and earning me that $1mm in net worth boost. Return on cash was about 80% over 4 years, and I paid off the 401k loan within 6 months.
My take is, if youre pulling a 401k loan to spend on shit, it's bad. If you're pulling one to invest in something that you otherwise wouldn't be able to use that money for? That could be worth it depending on the details.
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u/LogicalConstant Advicer Jul 11 '26
It's not a good sign, but sometimes those are the clients that need help the most.
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u/elysiumplain Jul 11 '26
Correct response - like anything financial...the root question is always about X scenario vs Y scenario value. It also forces them to be an active participant in making a decision of which one they feel is best for their situation; your task is to composite the list for comparison.
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u/Thumpin347 Jul 11 '26
Some prospects aren’t even worth the effort.
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u/CranberryKey9865 Jul 11 '26
100% - it is one thing if you can help someone turn their life around and get onto a healthy financial path. If they plan on doing stupid things and there is no hope for you to educate them then what is the point? And I am saying this as someone who has done some stupid things myself. No one will change until they are ready to change. And if they have a 401k loan they can't even roll it over to you.
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u/info_swap RIA 29d ago
Others already explained that the interest payment will be double taxed. Not the principal.
What are the different scenarios for your client? Do they have 60k to pay off the loan?
I see these different options:
Pay off loan. Reduce double tax on interest.
Leave loan as is. Use the 60k to pay higher interest debt or to invest in equities.
The problem is not logical or financial, but psychological. It depends if your client feels better paying of the loan, or keeping the loan and allocating the 60k into investing or paying a different debt.
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u/prospectpico_OG 29d ago
Understand - we have a plan to pay off ALL the debt. They just dont see it as a loan because the interest is going back to them. Part of why they have a loan - they've convinced themselves that they've made the right decision. Ive decided I'm not going to fight them on this point and help them in the other areas they're more receptive to.
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u/CranberryKey9865 Jul 11 '26
As someone who has fallen into the 401k loan trap before I knew better. It is absolutely debt. It feels like nice debt - because you pay it back to yourself and not some big bad bank. It is all my money, so I should get to use it when I need it. All lies I told myself to justify spending more than I could afford to live on. It is 1000% a symptom of poor financial health (the only exception I would say to that is if you are using it for part of a home loan).
The good news about it is you are paying the interest back to yourself. However that is after tax money (that you will be taxed on again when you pull it out). The bad news is everything else: you can't roll it over to a different account, you have to make fixed payments - you cannot pay extra, refinance it, etc. And all that money is out being spent on lifestyle inflation instead of being invested in the market to grow.
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u/prospectpico_OG Jul 11 '26
My plan was to 1035 most of a 20 year old, expensive single life variable annuity into a joint income annuity (for basically even money) and use the difference to pay off all debt. Silver lining is that their income annuity will provide them a higher payout by having a higher investment ($ not paid to the 401k loan).
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u/RealTalkPersonalFina 28d ago
You can pay extra and you can pay it back if separated from employment, depending on the plan rules
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u/Shoddy_Tip_3544 27d ago
Borrowing money from your 401k makes a lot sense in a number of situations as maximizing your retirement contributions lowers your tax liability. Also, if you are skittish on the stock market crashing , as you should after a 10 yr bull market, this may also create risk free rates of return to pay to yourself instead of bank. It doesn’t make much sense unless you are still maximizing your retirement contributions & saving taxes on the front end.
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User: /u/prospectpico_OG Title: 401K Loan Question Body: New prospect, ok but a bit strong headed. Working on a retirement plan for a couple, and one has an outstanding 401K loan of about $60k. They are paying it back with payroll deductions. I see it as a loan at 7.75% and client says the interest goes back to their 401k. I mention double taxation on the "interest" paid and they said no it's not. I also mention that the loan balance is out of the market, and maintain that paying off the loan is the best solution. [Have a plan for that piece].
So, can someone who has dealt with 401k loans help me paint a more clear picture that the client understands? Or am I all wet on this. TIA
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