@socaldad2002 No, I don’t think you will be double taxed. Our loan was a 20 year loan and wasn’t one which could be paid back early. So weird. Every year, they sent us the details. I checked it once.
Have you checked to make sure the numbers add up and if not ask the benefits dept?
As you know, you only pay taxes on the increase in value in the 401K. In normal cases, that would be the last amount minus what you invested but if you had a loan that interest would be taken out.
I think this type of loan is one of the best tools for people to buy their first house.
1 Like
If he exceeds the income limit for the Roth, then the best option is to put into a traditional IRA and immediately convert to a Roth. This is what many high earners to who can’t otherwise qualify for a Roth due to income limitations. He should check with his CPA but the benefit of compounding growth usually outweighs the tax he would pay on that conversion today. I was just having this discussion with my 18 year old about the benefits, also one being never having to deal with the RMD in a Roth, but I converted one of my traditional IRAs just over 20 years ago around the time when the Roths were first established by tax code and was happy to pay my taxes back then. One of them was renamed “The Roth Conversion for xxxx” (xxx is my name). I’ve never added money to that particular account again as a conversion and that money has grown about 7x to what it was then to a nice 6 figure sum. I would not at all want to pay taxes today on that money and am very happy I paid it back then since all the dividends have compounded tax free.
We have an appointments set up with our cpa and financial guy in January, so we’ll ask how/if a conversion strategy would work for him. He’s most likely changing his brokerage account to one that interfaces with the companies 401k plan just to make things easy. So now is a good time to take a look at the big picture.
Beware in that if you leave or get laid off by your employer, a 401k loan must be repaid in full or be counted as a withdrawal (with taxes and penalties depending on the situation).
2 Likes
Another tip for young adults - As soon as possible, try to get into the mode where you purchase cars with savings rather than car loans. Even with decent salary it does take some time to do that and also build up an emergency fund and save in 401k … but tis a very worth goal.
1 Like
Hmmm, we’ve always taken out auto loans. The interest rate is very low and we’ve felt that investments have made more than the interest we’ve paid in an auto loan. Same with our home loan.
Maybe I’m wrong.
My kids have paid off their car loans early. I keep hitting deer right when the car was paid off That stinks
Well certainly car loans in recent years have had lower interest rates than in the 1980s (when my grandfather bankrolled my first/only car “loan”, 9% interest … a good deal for both of us, and he was assured of getting a letter from me once a month with the check)
Better to be in a position where you can buy a car in one payment, so that you have the option of buying it that way or using a loan or lease, depending on what happens to be most advantageous at the time.
1 Like
Some are, some aren’t. Ours wasn’t. But then again wasn’t flexible in payments. So became annoying. Some companies allow tou to jerp the 402k if you worked there. We eventually rolled it over ( after tge loan was paid).
1 Like
Depends on lots of factors. Growing up my parents drove their cars into the ground and bought them with cash. I thought this was thrifty. Then I made enough money to have options: auto loans have low rates, leases often included services. I realized auro financing has multiple options.
For people who are self employed most leases are deductible ( which can be pretty appealing esp if you have an expensive car and can’t write off many miles.
I have never paid cash for a car. Usually buy something moderately expensive so the money can make more than 3%.
1 Like
We have paid cash for our cars for the last 20 years. It just fits our risk profile. If the stuff really hits the fan, nobody can repossess our cars and we don’t have to worry about it. We also paid off our mortgage when it got below $75000. (But we have a $150000 HELOC with a balance of $500 in case we need to tap equity fast). There is no one best answer.
ETA, those who are not self employed have few , if any, ways to tax advantage vehicle leases or payments.
3 Likes
When my kids were in lower brackets, they made the max payments they could make to Roths each year.
@srparent15, I assume that the conversion to Roth only makes sense if you think your tax bracket will be lower later. If it is always high, does it still make sense? Or am I thinking about it incorrectly.
We live in a lower tax state and have paid off our mortgage, so the higher standard deduction was a boon to us. It is unfair that state governments who choose to impose high taxes on their citizens should have the burden subsidized by less in federal tax. Those state governments should reduce their tax burdens, and that’s where your attention should be focused - or move out. That’s why we have turned down relocation offers to the NY/CT/NJ area and California (although we have had to pay California tax some years because of their ridiculous laws despite not having set foot in the state- taxation without representation). Personally, I would much rather see a flat federal % income tax which would be a lot simpler, like my state income tax. We’d probably end up paying more at some point, but it would save days of work every year. This would eliminate the ridiculous gyrations we are going through to plan Roth vs Conventional, etc. to reduce our payments to the government in retirement.
I seriously cannot see the high tax states reforming ever, and I sympathize with your plight. The only remedy is to stop voting for the idiots who keep enacting the increases or move out - and never vote for a similar set again.
At least where we live (midwest) I have not seen a change in giving patterns after the tax reform. That’s probably because we were a lot less negatively affected.
2 Likes
don’t forget about the tax brackets of your heirs, shaw. If they are making bank in say, NYC, where marginal brackets are 50+%, you paying 37% to leave them a tax-free Roth might make sense. (assuming they are still in extremely high tax situation when they inherit)
Am I misreading this? This doesn’t seem accurate to me. Anyone else?
If the 401k is a pretax 401k, the statement is incorrect.
2 Likes
Former 401k admin here. Interest paid on a 401k loan is not taxable income at the time it’s repaid. Said interest goes back to your account, not to the plan. (That said, 401k plan administrators are allowed to charge reasonable fees for processing the loan.)
401k isn’t taxable til money is withdrawn. If you have a 401k loan and it goes into default or you leave the employer and it becomes due, the outstanding balance becomes a taxable deemed distribution. You’ll get a 1099-R that reports the amount that you’ll have to report on your tax return (and pay taxes/early withdrawal penalties if you’re under 59.5).
5 Likes
The problem with a flat federal income tax is that would hurt the lower income and help upper income people and winds up being a regressive tax. A progressive tax works much better for that. For states that have no income tax there are other places that recoup the taxes in lieu of state taxes. Unfortunately, other services tend to be lacking and public schools tend to not be as good in some of those areas as well. I live in a state with a flat tax and the upper income earners definitely don’t pay nearly what they should.
Also regarding state taxes, there are many ways to reduce those - ie in our state making contributions to a 529 is a state tax deduction. Also while higher, when you pay your taxes in CA (I do as well and know it sucks) you at least get a credit back on your state taxes although not as much since again CA is so high but at least you aren’t paying double.
Question maybe you can answer as this is this is one thing I’m not overly familiar with and maybe you can help. I have a 401k, can I convert it to a 401k Roth just like I have been converting my SEP to a Roth or are the rules for a 401k Roth different? I still have some $ in my SEP that I haven’t converted as I’m only committing a portion every year (should’ve done it on day 1 years ago) to not get hit with an outrageous tax bill now but wondered how it works with the 401k.
Thanks
Definitely something to talk to your accountant with but there are a variety of reasons also to convert. A) if you can afford the taxes B) if you convert now you have to wait 5 years to take anything out, other than the original contributions, so just remember that point C) you don’t have to deal with the RMD rules…my dumb husband never paid attention to his mom’s IRA and at 91 she has to take an RMD (not this year due to CARES) so every year she has the required distribution which she then has to pay taxes on. While she doesn’t have a lot, it’s about 10k and with social security and a pension she has, it winds up costing her 2k in taxes. This year we didn’t take the distribution since it wasn’t required, however, one question that came up as @bluebayou similarly is that my MIL is in a lower bracket than my husband and me so if she pays the taxes now, it is less than taxes my husband would have to pay upon inheritance. However, there are beneficiary rollover rules that don’t require an instant rollover. D) tax rates are lower now than they might be in a few years so that’s a consideration with converting now or later…just had that discussion with my accountant re selling stock now and taking capital gains E) tax free growth on earnings is a big one (if my MIL had done this then no RMD and even if she did need the money to subsidize her living it is tax free), I have almost all of my retirement money in Roth IRAS and keep adding and I’m thrilled to know we will have little income to worry about, also makes taxes easier, I see dividends pay into those accounts and nice to know I’m never paying taxes.
Your point is right about your tax bracket being lower later but that’s an analysis you need to make with your accountant because let’s say your IRA was in something like Square last January 2 and you had 100 shares. It was 63.83 so you would have had $6383 of stock in your IRA. If you converted it immediately to Roth you would pay the taxes on that. Ok, so today it is at 227.80 so instead of being worth $6383 it’s now worth $22780 and if suddenly now you’re in the lowest bracket at 10$ you would owe $2278 but if you were at the highest bracket at the $6383 you would have paid at 37% (income >622K) you pay $2361, So, it’s virtually equal but that’s a stock in one year and where will a stock be in 20 years if someone waits to convert it. Of course many stocks will be lower, some will be higher, some will pay dividends so that’s also income added to the Traditional IRA that will be ultimately taxed vs not in the Roth and there is no guarantee you would be in the lowest bracket because even in that scenario when that conversion is made, the income is actually $22,780 so the only way someone is in that bracket is if they essentially have no other income and the deductions wipe out the income.
Hope that example makes sense. For me, I have not converted all my SEP IRA money because it will put me into too high of a bracket now, but I do convert each year especially now as my income is on the lower end compared to prior years.