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Do not take a 401K Loan ad"vice"

I have seen many money experts and the most intelligent of people trip on this one.... They say do not take a 401K Loan...In my mind 401K loan is one the best sources of funding out there.....Let me explain. 

 Myths about 401K loan:

  1. Double Taxation : You take Pre-Tax Dollars as Loan and Pay in Post-Tax Dollars One of the biggest myths out there.....the way a 401K loan works is you take money from your 401K account (upto 50% of your 401K balance) which is pre-tax money ...and pay back through your after-tax pay-check deductions with interest (typically much lower than any bank loan ..currently 3.75% on Vanguard).... 
         When ever some one says this to you....simply ask them when you take a loan from a bank..do you pay in pre-tax or post-tax dollars?...clearly post tax dollars..... If they are not convinced explain it to them this way...lets say you take 10K out of your 401K account as a loan ....you are taking money that has never been taxed....assuming your tax rate is 30%...you owe 3K to the government on that money.....when you pay the 10K back you pay with pre-tax money of 14.2K.....but this money will get taxed any way...whether you paid it for the loan or not....you still owe that 3K on the original 10K you took out of the 401K account...even though you paid 4.2K on the 14.2K....the key to realize here is that....the total money involved is 10K + 14.2K = 24.2K.....both your earnings...that have to be taxed at some point in time....
     Double taxation does occur on the interest portion of the loan...i.e; let say the interest is 3.75% ...you will pay $375 on 10K in a year which has already been taxed into your 401K account....but this is a low price to pay (for all the tax free gain you will get over a long period of time)...also remember the best part is the interest your are paying is to yourself not to any bank.

2. You will loose out on the market gain:

For this I would say the classic "All investment involves risk"............to explain this I would say the decision should be made on how you are going to invest/use the loan....Ways you may gain:

Down payment on a house: say this going to be a down payment on a house which will get you to 20%..then you would save a ton on the PMI (Primary Mortgage Insurance -- charged when you put less than 20%) and also on the favourable interest rates you will receive when put 20% down...

Investment return is greater than market return: If you invest this money where your retutn is higher than market or use this money to pay of high interest debt (say 15 to 20% and the market return over this year is less than this) ... you gain.

Market is flat or goes down : You will dollar cost average in a flat market and you will buy at lower prices when the market is down.............and will be better off with the 401K loan...

Only case when you will loose is when the Market goes higher significantly...but remember you will only take out a max of 50% ...so you will earn market return on atleast 50% of your money...and you will not loose out on the whole return on the remaining 50% as you will buy into the market as it is going up...and not at the highest point...so you will loose out on about half the return...

3. You will hurt your retirement income: This will only happen if you don't pay back the loan....so definitely I would not recommend taking a loan if you think you may not be able to pay it back.... 

  In conclusion I recommend 401K loans for alternate investments to diversify your portfolio or to pay of high interest debt........

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