Should I take a loan from my roth 401K plan and invest it?

[wcrile]

Hi, all. Here's a scenario I'd really appreciate your opinions on;

I have 25,000 in my employer's roth 401 K account. I can take out a loan from this amount at 5.5% interest and pay it back over the next few years. What I'm thinking of doing is taking a loan for 10,000 dollars for 3 years, and lending it to a family member's business at 10% interest for 3 years.

During this time period, I'll probably reduce my normal 401-k contribution to offset the pay roll deductions for the loan repayment so as to pay back the loan quickly over roughly a year. Does this sound like a good idea? Am I missing any risks or not thinking of something here?

I know I could loose my job, and be liable for the full loan amount, but in that (unlikely I hope) scenario I have some savings that could cover the loan. Aside from that, and my family member's business defaulting on my loan, is there any reason not to do this? Oh yes, and I guess depending on what happens to the market, I could be missing out on some returns (although they've been essentially flat for the last two years anyways).

The loan interest is essentially me paying myself, and if I can get 10 percent elsewhere, why not? Thanks everyone for your thoughts!

[david rigby]

By all means, if you can borrow at 5.5% and get a guaranteed return of 10%, do it.

There are no risks:

- lose your job? No risk there.

- default of your family member's business? No risk there.

- mis-estimate of your 10% return assumption? No risk there.

- loss of diversification in your investments? No risk there.

- risk of family alienation? No risk there.

[hr for me]

If you reduce your 401k contributions, will you be lowering it enough to lose out on company employer match? There's not an investment greater usually than employer match.

Honestly, if you have the money elsewhere to be able to pay the loan back, why not just use that $ to loan the family member and then if/when you would have needed that money personally, then take the loan from the 401k.

(But I will admit my bias against 401k loans -- to me it is just another debt which I try to avoid.. Too many lower other savings to pay for the loan payment and you are really setting back your own retirement during the time you have lowered your contributions and possibly lost match. If you can't afford to give the family member the $ directly, you can't afford it. Playing stock/investment broker with your 401k account is not smart.)

[shERPA]

Short answer, no.

The whole point of Roth accounts is the tax-free nature of growth on the account. Even if everything works out as you hope, you will pay taxes on the 10% interest paid to you from the family member, reducing your net to somewhere between 5% to 7% depending on your marginal tax rate. This just about equals what you will pay in interest to your Roth account (this interest is not tax deductible). So you are now at a wash. And if your Roth account might have earned 7% or more during this time, you are now in negative territory in terms of your own net worth, because it is only earning 5.5%.

And this is the best possible case. Throw in risk factors and it makes no sense at all.

[ETA Consulting LLC]

Don't listen to 'hr for me' or ShERPA. Just listen to David. I cannot fathom any risks with your approach.

Please forgive me that this post is a bit out of character for me. I just had to do it.

On a serious note, this discussion should end at your ability to take out a loan of about $12,500 (depending on your plan's loan provisions). Everything else involves a personal investment strategy that doesn't impact the plan; and (I think we all agree that) your reasoning sounds very dangerous.

Good Luck!

[AndyH]

Sure. You lose tax free growth of the $10k. The 10% earnings are taxable. Your loan payments are paid with after-tax money and are not deductible. You lose tax free grown on the reduction of your 401k deferrals.

Plus what David said.

[BG5150]

Plus, you are taxed twice on the interest payments.

[My 2 cents]

Don't listen to 'hr for me' or ShERPA. Just listen to David. I cannot fathom any risks with your approach.

Please forgive me that this post is a bit out of character for me. I just had to do it.

On a serious note, this discussion should end at your ability to take out a loan of about $12,500 (depending on your plan's loan provisions). Everything else involves a personal investment strategy that doesn't impact the plan; and (I think we all agree that) your reasoning sounds very dangerous.

Good Luck!

My main concern in reading David's post and then this one is that they might not make it obvious enough for a non-expert to recognize the heavy dose of sarcasm. In case there is any doubt, those items described as not involving any risk are, in fact, definitely possible sources of risk arising from the proposed strategy.

What do they say about lending money to a friend or family? As one quote points out, "Thanksgiving Dinner tastes better when nobody at the table owes money to another person at the table."

[wcrile]

Thanks, everyone for the helpful feedback. Sounds like the consensus is it's not a good idea. A few things to clarify from my end;

1. I'd be cutting my roth 401-k contribution from 20% of my pay to 10% (not enough to affect the employer's match) I'd still be contributing, albeit at a lower percentage.

2. The loan and 5.5% interest is me paying back myself

3. On the tax question. My roth 401-k contributions already aren't deductible, and are contributed after taxes, so I'm not so clear on the 'double taxation' comments.

4. My earnings on the 401-k have been essentially flat for the last two years, so I don't buy the 'giving up future earnings' case. Couldn't you just as easily say 'giving up future losses' depending on what the market does?

Thank you all again. It's been an education for sure!

[MoJo]

With respect to your Point "4" above: "Past performance is not a guarantee of future performance."

Retirement plan investing is LONG TERM, and the past 2 years are but a blip in the time horizon. Plus, when the market is low, you are "dollar cost averaging" into cheaper shares/units which, when the market rebounds will magnify the upside.

[Bill Presson]

Plus, you are taxed twice on the interest payments.

I don't think this is accurate for a Roth account. Interest payments are made after tax, of course, but the earnings on a Roth account wouldn't be taxed when distributed.