How Should I Tackle Paying Off a 401(k) Loan?

July 6, 2023

In this highlight, we talk about if you should pay off your 401(K) loan.

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Do you have guidance for those of us who took out a 401k loan for a home before we became financially savvy mutants? Should I pay it back ASAP at 3.15 percent? Does the repayment count towards my investing percentage? It sounds like he’s trying to go back and undo something he regrets in retrospect. How should he handle this? Yeah, this is a common misconception with 401k loans. People think, ‘Okay, I’m going to borrow money from my 401k, it’s going to be great. I’m going to make the interest and pay myself back.’ What you fail to recognize is the significant opportunity cost involved. Would you say the loan on the percentage is 3.15? Oh, that’s great, I’m going to borrow at 3.15, it’s going to be so significant. But the cost is not only that 3.15 percent. You have to pay yourself back, and by the way, it’s an amortizing loan, so you’re not truly making three percent on that because each payment includes principal and interest. Your actual return is even lower. The big thing is that your dollars are no longer working for you. You are taking them off the field. If you’re a young person who understands our wealth multiplier, you recognize that taking my army of dollars off the field when it is game time, when they can be most powerful for me, is not ideal. So, I would argue that if you took out a 401k loan before becoming a financial mutant and now you are a financial mutant, starting to recognize this, I would love to see you put those contributions back in and pay off that loan so that your dollars can get back to work. I’m even a proponent of going above the 25 percent savings to get that thing satisfied. If you have to, get it satisfied so that your dollars can work for you. Another thing people don’t realize is that if I have an outstanding 401k loan and I’m terminated, want to change jobs, or leave, I either have to pay it back immediately or face a big taxable event. If I’m under 59 and a half, it will be taxable plus penalties, which can be substantial. In my opinion, bro, I’m curious if you agree, I think Matt should quickly get those dollars back in the 401k, without a doubt. Because when I put some numbers to what you just shared, Bo, if the interest rate is 3.15, we hear that’s low interest, but if the market made 10-12, think about the fourth quarter of last year. We know 2022 wasn’t great, but the fourth quarter actually made some money back, and then the first quarter just closed, making some more money. What if there’s been a 10 difference from the time you took this loan? That loan didn’t cost you 3.15, it actually cost you 13.15 of what? And that’s compounding because it keeps piling on top. So, do exactly what Bo said. I think this is even above the 25 percent. Get busy, get that money paid back now that you know better. You’ll know not to touch that. That is something that’s there for emergencies. It’s got to be a tremendous emergency to pull any of your army of dollars off the field, especially to get access through a loan on your 401k. That’s just not our favorite thing in the world.



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