shankar_v_prasad[at]hotmail.com (Shankar Prasad) wrote:

- quote -

This whole "investment/loan scheme" is kaka. First, the
"interest" you pay (to yourself) on the 401(k) loan is NOT
DEDUCTIBLE as investment interest. Remember, you are
borrowing your OWN money, and paying the interest back to
yourself.

Second, the "interest" you pay (the 5%) is AFTER-TAX money,
but once you pay it back to the 401(k) account, it changes
to PRE-TAX funds. You will pay income tax on this money
whenever it is withdrawn in the future. Any interest you
earn in your savings account "investment" is also subject to
ordinary income tax, further reducing any "gain".

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"Shankar Prasad" <shankar_v_prasad[at]hotmail.com> wrote:

- quote -

I will only answer relative to the question of deductibility
of interest paid on a 401(k) loan. All other aspects are
not tax questions and beyond the scope of this forum.

The answer is no, its not deductible. You can't deduct any
amounts you pay yourself.

--
David M. Woods, EA, ChFC, CLU
Woods Financial Services
Boston, MA 02109

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shankar_v_prasad[at]hotmail.com (Shankar Prasad) wrote:

- quote -

Even if the 5% is tax-deductible, I think you still come out
behind. Assuming you're in the 28% tax bracket, the 5%
interest you'll pay is equivalent to 3.6% taxable interest.
So you'll be paying 3.6% to increase your earnings by only
1% (actually less of an increase because you'll be paying
taxes on the additional earnings). That's a net loss of
over 2%.

--
Barry Margolin, barmar[at]alum.mit.edu
Arlington, MA

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I had a question about deducting interest paid on 401K Loan as
"Investment Interest". Background:
- my 401K is currently significantly invested in money market
(CPMXX) paying less than 1.00%. At present, I am not
comfortable putting this elsewhere in stock/bond fund. My
employer does not offer a Stable Value Fund, which I would
like.
- other money market options (such as Virtual Bank savings
a/c) are paying more than 2% (about 2.14%).

I would like to withdraw some amount from my 401K as a loan
(permitted by my employer) and put it away into either ING
Direct (www.ingdirect.com) or Virtual bank
(www.virtualbank.com)'s Savings Account. Both of these are
FDIC insured and pay more than 2%. I will have to pay an
interest rate of 5% (calculated as prime + 1%, but fixed for
the duration of the loan) for the 401K loan, which is
deposited into my 401K account. There is a $50 loan setup
fee.

With this maneuver, I expect to achieve two things:
- my 401K account will effectively earn 5% on the loaned
funds (rather than CPMXX's 0.93%)
- since the 5% interest comes from my repayment, it kind of
increases the amount I am able to effectively contribute
to 401K

Cashflow-wise, I am at a small disadvantage, as the loaned
funds earn 2% (taxable), but I have to pay 5%
(tax-deductible ?) I believe I can handle this cashflow
issue.

Networth-wise, the benefit is that the 401K Loan balance
earns 2.14% (at Virtual Bank), rather than 0.93% (CPMXX). I
will invest the loan proceeds only in safe investment (like
the FDIC savings a/c etc) so that there is no risk, as well
as ensure liquidity in case it needs to be repaid quickly
(like change of employer).

My question is whether the 5% interest being repaid from my
paycheck (to the 401K Loan) can be considered as an
"Investment Interest" Deduction (on Schedule A/Form 4952 ?)
The loan proceeds check will likely be deposited into my
personal checking account (which handles my salary and other
expenses) and then EFT-transferred immediately to a new ING
Direct or Virtual Bank account. So, I should be able to
trace that the loan money was used to invest in the savings
account. I was wondering whether the fact that the repayment
was to my "own" 401K account would affect deductibility of
the interest as "Investment Interest".

I already use Itemized Deductions (due to mortgage
interest). I expect to have enough investment interest -
other savings a/c interest (1099-INT), money market distr
(1099-DIV), other dividend distributions from existing VWEHX
(Vanguard High Yield Corp Fund) etc, so that "Investment
Income" exceeds "Investment Interest". If it doesn't, I
guess I could carryover too.

I believe this maneuver makes financial sense only if the 5%
interest I pay is deductible - since the interest paid will
be subject to taxes (at ultimate 401K withdrawal time).

Any suggestions on alternative safe & liquid investments
(the farthest I could go on liquidity is 3 months or so) for
this (instead of ING/Virtual bank) are also invited.

Any suggestions on the usefulness or otherwise of this "401K
Loan - invest in Savings account" plan are also invited.

--
Regards
Shankar Prasad
shankar_v_prasad[at]hotmail.com

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