Question on Nest Egg Building Strategy

[cputrwz]

So, hubby and I need to start saving for a downpayment on a house in the next 1-2 years. I can't really start crazy saving until the end of the year when we move into a much much cheaper apartment but I wanted to get a strategy going.

 

Once we move, I'm going to up the percentage amount that I put into my 401k and be able to put more aside for savings... and I know you can take a loan out from your 401k to help with a down payment on a house (and also general purpose loans).

 

So, my question is.... which would yield me more money in the long run:

 

1. Take a loan out on my 401k earlier than I need it and dump the money into some kind of high yield savings or CD. IE: would this help gain more money than I would leaving it in the 401k? (My 401k hasn't exactly been doing well lately). Right now, I can take about 5,000 from my 401k.

 

2. Leave the 401k where it is and just stick with dumping more money in it per paycheck and trying to just put money aside each month?

(And hope it doesn't actually decrease in value).

 

I don't have any kind of liquid cash to dump in a CD or anything right now... I have a little CD with Navy Federal that has a whopping 300 bucks in it!

 

When we move, I will be saving over 1,300 in rent expense and probably a lot more in gas and other utilities. So, I hope I'll be able to start stockpiling away better then.

 

Any suggestions or yay/nay on my options are appreciated!

[Kevin20]

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Edited July 13, 2012 by Kevin20

[Kevin20]

Don't take a loan out on your 401k at all. Just don't do it. It's a terrible idea. It's too risky. Here's why:

 

- First, you're not borrowing from your 401k in reality. You are taking out a loan from the 401k administrator. They set aside an equal chunk of your 401k balance as collateral, so that you do not see that amount in your 401k balance anymore. It looks like you have borrowed money from yourself, but that is NOT what happens.

 

- If you happen to lose or quit your job while that 401k loan is still outstanding, the entire remaining loan is due immediately. You will not be given time to gradually pay it off.

 

- The only way to preserve your 401k balance in that case is to come up with the remaining loan balance from some outside source (ie other savings).

 

- If you don't have enough savings on hand to pay off that entire loan, then the 401k administrator seizes the collateral that had been set aside. That amount (the remaining loan balance) is thus immediately counted as taxable income, a premature withdrawal from your 401k.

 

- You therefore are taxed on that amount at your highest marginal tax rate, plus a 10% penalty; and that money has forever disappeared from your retirement savings.

 

So what happens is you lose your job unexpectedly, AND a good chunk of your retirement savings has vaporized, AND you get jammed with a monstrous tax bill while you're still trying to find another job.

[cputrwz]

Actually that's not true, I've been able to set up repayment plans on 401k loans after I have left a company before.

 

I appreciate your feedback and your perspective but I would like my questions to be answered as I asked them. I am aware of the risks and pitfalls with 401k loans.

[saladdin69]

Actually that's not true, I've been able to set up repayment plans on 401k loans after I have left a company before.

 

I appreciate your feedback and your perspective but I would like my questions to be answered as I asked them. I am aware of the risks and pitfalls with 401k loans.

 

 

You asked "WWYD", you can't be upset when someone doesn't agree with you.

 

 

Your questions are moot for me. I would never borrow against my 401k. That is retirement only. My retirement comes first, always. I would ( and do) max out retirement first, then see what that leaves me able to buy in mortgage. Retirement is generally protected in BK, I would not want to lose my house and retirement and the same time.

 

I would not want to gain a mortgage AND a 401k loan re-payment at the same time.

 

You will also be gaining house insurance, property taxes and maitenance. You will not be saving close to as much as you think.

Edited July 13, 2012 by saladdin69

[cputrwz]

Yes, what would you do based on the questions I asked... I simply want to know if I would gain more money in my 401k and leave it there or do a withdrawl and drop it in an interest baring account.

 

When I say I'll be saving money I'm referring to us moving at the end of the year and RENTING a much cheaper place and then buying something a year or two after that.

 

I will be using my 401k to help with the downpayment, so the posts to tell me not to do it are moot to me.

[Seabee]

Does your plan allow you to continue contributing to your 401k if you have an outstanding loan? You could miss out on your employer's match, which is a hard return to beat.

If you're 401k is losing money, have you considered moving to safer investments in the 401k? There should be at least one low risk/low return option.

Whatever investment decisions you make, it's all a game of balancing risk vs anticipated return. Obviously 401k loans come with risk, which is why I'll echo saladdin's comment of 'just don't do it'. But since you've made up your mind already on that point, be sure to add the risks into the equation. The potential negatives are very real. A 1099R with distribution code 'L' is painful, especially to someone who has just lost his job.

[cputrwz]

Yes, I can continue to contribute with loans... employer also matches your loan payments.

 

I have moved things around a bit... it has gotten better but ultimately it doesn't move around a whole lot. Only seems to go up when a contribution hits it.

 

Right, I understand. I have taken 401k loans in the past, I know how they work... I have also just taken the hit for the taxes as opposed to paying it back... it wasn't bad at all. Course, I'm not withdrawing 10's of thousands of dollars.

 

I asked a couple coworkers and they said to just leave it there and see what happens to it by the time I actually want to do the downpayment loan... but meh... dunno. I have the money spread out quite a bit in the various stocks and bonds that they offer... some in stable value funds and some in low risk and some in the growth stuff... just seems to keep going down.

[road2freedom]

Hey cp, I have some thoughts on this. You've already mentioned that you know what you are getting into with the 401k loan, so I'll leave that part alone.

 

I do not think option 1 is in your best interest, literally. If your 401(k) isn't outpacing a HYS or CD, then you need to re-evaluate your investments and any fees. There's good money to be made right now. Does your plan offer free advice by chance? I'd be willing to help if need be, but "I'm not a licensed financial advisor" and all that jazz... I've just been in the 401(k) industry for 11 years.

 

I actually like option 2 and this is why....

-First, you are benefiting from the tax savings of putting money in the account for now, which in turn probably frees up a few more bucks to contribute.

-Second, since you are putting extra money in with the intent of borrowing it anyway, no harm no fowl imo. This money would not have been there in the first place, so removing it from investment is not the same as if you were borrowing your true nestegg.

-Third, if you aren't already maxing out the company match, if there is one, this could be additional free money which not only benefits you in the short term goal of getting a loan, but also in the long term of retirement assets once you pay it back.

-Fourth, assuming everything works as planned you will eventually have forced yourself to save extra money for retirement, because you weren't planning to put this in there before the house hunt came up.

-Finally, in some cases the loan is not counted in front-end and back-end ratios. This is not always the case but may work out in your favor depending on the lender.

[cputrwz]

THANK YOU ROAD! I appreciate the comments and advice and I think I agree with you. I was just tossing around the ideas and wanted to make sure I was leaning toward the best route (for what I have decided!).

Edited July 19, 2012 by cputrwz

[road2freedom]

One other thought... and I cant believe I didn't mention this. There is a limit to how much you can borrow (usually 50% of vested balance). You will lose half the utility of this money if you plan to take a loan against it. If you put in another 2k, that only increases your loan availability by 1k. The only thing that could offset this is if you are earning additional dollar-for-dollar match for these extra contributions and you have already met the vesting criteria.

[cputrwz]

Right, which is why I had initially asked the question... we do get employer match 100% up to 2% of my salary and then after that it goes down.. I think at 3% they match 85% of it and so on.

 

I may just up my contribution a little bit and then start saving on the side into a CD or something. I am hoping I am able to save up like 1k a month if all goes according to plan (even after bumping up my 401k contribution). I also want to pay off as many of my bills as possible. We have a few small credit card bills and if I can whack some money off my student loans that may help.

 

I am really curious as to how my student loans will come into play into how much house they will let me borrow. When I got my first home my student loans were all in deferrment and I don't think they factored them in. But, by the time we buy, I will be paying on all of them... I have about 100k in student loans right now and I think the payments on them will be about 550 a month for all of em.

 

Do they just look at the monthly payment compared to your net income or do they look at the total debt vs your annual salary?

[road2freedom]

In my experience it's a monthly analysis. They will look at the front end ratio which should generally be under 28% (monthly gross / PITI) and your back end ratio which should generally be under 36% (monthly gross / PITI + all other monthly debts).

 

PITI = principal, interest, taxes, insurance

 

The ratios can change based on the program and lender requirements. Some are much more lenient. Note - these are considering gross, pre-tax amounts.