Background

I took a 401(k) loan to facilitate a move across state (My wife is a newly graduated physician who took a residency offer near our new home). I up and switched jobs in the same career field to stay with her, and failed to properly vet the organization I was joining. As such, I am switching companies to one that I have had more time to properly vet and have a discussion with.

We have enough emergency money to cover expenses even if I lose my new job in the first couple weeks of having it. Using the emergency money to cover the outstanding 401(k) loan is not an option, as it would introduce an unacceptable level of risk into our finances. The field I am in has such a desperate lack of qualified workers that I can be assured of a new offer within a week of losing a job (though the company may be unsavory).

Question

I am exploring options for mitigating the financial loss that would occur should I default on the outstanding 401(k) loan (~10k USD). I can handle the tax and penalty hit should I need to, but I feel I have other options available.

I can take out an unsecured line of credit for the outstanding balance at a 5.5% APR (credit score over 770 at last report), which will be a significantly reduced cost in the long run, but will up my cash outflow in the short run, thereby increasing risk. I can mitigate that risk by taking an identical 401(k) loan after the new plan allows, thereby seating myself back in the same situation, with a small cost of transaction.

As far as I see, those are the three most prominent options (Take the hit, including taxes; cover the gap with an unsecured line of credit; or use an unsecured line of credit to bridge between 2 401(k) loans) . I'm not asking for a decision to be made for me, rather, I'd like to cover the pros and cons of each option to minimize my mistakes and risks. I am relatively inexperienced as far as juggling debt goes. If it matters, the 401(k) account for both companies will be with the same lender on a similar-but-not-identical plan setup.

The answers thus far hit on our unwillingness to pay down debt. To forestall another post point out that debt is a choice (I agree, it is), I will lay out where our income is going.

My wife will not make a doctors salary until she has completed her 4 years of residency. Until then, our household income rests at roughly 120k USD annually (dependent on my overtime). Her student loans cost nearly 4,000 USD monthly, and our only consumer based debt is her car at under 400 USD monthly. We do use a joint credit card, but never beyond what we can pay off that month. Neither of us has ever owed or paid any interest on a credit card. The 401(k) loan in question costs 427 USD monthly; with a mortgage of just under 1,100 USD monthly, that puts the present (not future) cost of the decision to own a house at par with renting an equivalent apartment in the area.

  • I'm confused - so you have a 401(k) loan with a company that you've already left, or with the one you're considering leaving? – D Stanley Oct 22 at 13:41
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    @DStanley As of this morning, just left. To clarify, I left Job 1 to move, got to job 2, then took out the 401(k) loan, and have just left job 2 to move on to job 3. – GOATNine Oct 22 at 14:00
  • Can you rescind your resignation and hold out until the loan is paid off? That's the best move (financially). – D Stanley Oct 22 at 14:06
  • Due to health concerns, that is not feasible. The position this company put me in is not sustainable. As I mentioned, there is a direct lack of skilled labor in my field, and this company decided to place me in a position well above my capabilities without sufficient support. The stress is resulting in trips to the urgent care (ulcers/insomnia/psychotic episodes). While I could remain, I imagine the eventual health bills will be far more expensive than the tax penalty. – GOATNine Oct 22 at 14:14
  • Is job 3 already lined up? Do you know that it has a 401(k) plan, it accepts incoming rollovers, it allows loans, it doesn't have a long waiting period to join the plan? – stannius Oct 22 at 15:50
up vote 20 down vote accepted

I would NOT "take the hit" and pay the taxes and penalty unless you had no other choice. That's effectively paying ~35% "interest" on the loan. The best financial decision is to use all but 1-2K of the emergency fund to pay off the 401(k) loan, then save like mad to build it back up. I would also not take out another 401(k) loan. Remember that with a 401(k) loan, the true cost is the opportunity cost of not having your money invested in the market, which can be upwards of 10-20% in bull markets. Plus as you know, if you leave your job, the loan is due in full, which can leave you in tight spots like you are in now.

Yes, using your emergency fund increases risk from the standpoint of not having a large emergency fund in cash, but with a decent credit score you can always borrow money later if you need to, or find other ways to deal with the emergency.

Finally, I would look at why you felt like you needed a loan in the first place. I get the sense that you've acted somewhat impulsively in the past, borrowing money to fund your actions without a real plan of paying it back or knowing what the true cost is. If this is a pattern that will continue, then that's fine, but I would build an even larger emergency fund to finance these decisions, rather then borrowing money and not having to deal with the consequences until later.

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    Upvoted despite our disagreement in recommendation. However we both understand the core issue. – Pete B. Oct 22 at 14:18
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    30 minutes extra commute (per person!) for "a few hundred dollars" doesn't strike me as a good idea. Pertinent: mrmoneymustache.com/2011/10/06/the-true-cost-of-commuting -- keep in mind that money and time you put into your car is sunk down the drain, whereas money and time you put into your home with a better location is building equity. – Charles Duffy Oct 22 at 16:00
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    @GOATNine 20-30 mins more times 2 is a lot of time. I currently lose 2,5hrs a day to commuting and I hate it. I'd rather work that time. – DonQuiKong Oct 22 at 16:02
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    @DStanley driving 30 minutes after a 14 hour shift very well might literally kill OP's spouse. – stannius Oct 22 at 18:28
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    @DStanley just to clear the air, we are in no way anywhere near insolvent. A mess may be an accurate assessment of the situation, but we still have a net inflow of cash, and I retain the ability to earn more with just more work. Even the job transfer has sound financial reasoning behind it: I'm migrating from Salary to Hourly for a better rate, with the same schedule of hours, and a third of the commute. I didn't just bail because I don't like my job, I stuck around until I found something better. that being said, you are as always a font of good advice. – GOATNine Oct 23 at 11:25

There is another option (which is the one I would choose):

Establish a line of credit. This will cost a small administration fee, but if you don't use the line of credit it won't cost any interest. Use your emergency money to pay off the loan, and then, if it turns out that you needed the emergency money, use the line of credit. (Do it this way, so that you can still draw on the line of credit, even if you have both lost your jobs - when the unsecured loan might not be available.)

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    Ideally, this is what the unsecured personal loan would be. My preferred banking institution doesn't hand out unsecured lines of credit though, hence the loan terminology. – GOATNine Oct 22 at 16:41
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    Can you not get a credit card anywhere else? – Adonalsium Oct 22 at 19:37
  • Credit cards are different from lines of credit in that they can be withdrawn from (like taking out credit as cash). I have no desire to get another credit card, and it would not do anything in this situation. – GOATNine Oct 23 at 11:20

I'm not asking for a decision to be made for me, rather, I'd like to cover the pros and cons of each option to minimize my mistakes and risks.

This question is very much situation and personal dependent. What will your wife's new income be? How much student loan and other consumer debt are you carrying? Will your new area offer better salary opportunity or worse for you? Will you two live the "doctor lifestyle" now, or live well below your means to get debt paid off?

All of those things changes the calculus of risk versus cost.

However from your post I am assuming that it is your intent to now live the doctor lifestyle and not work on debt. I assume this because you are talking about defaulting on a 10k loan that needs to be paid back in about 6 months. I am assuming your household income is at least 150K/year.

The answer to this question, like many others in personal finance, comes down to one of behavior not math. You two are fully capable of paying down this loan in two months, let alone the 6 months that you actually have. It will be a matter of cutting your spending, getting on a written budget, and earning as much as possible. That 401K loan will be paid off in no time, and then you can work on other consumer debt.

If you two are not interested in doing that, I would recommend to "default" or pay the taxes on the 401K loan. It is highly inefficient cost wise, but as you said it reduces risk. You two will probably be giving such a large portion of your future income to banks the current costs really don't matter much.

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    For the next 4 years, the majority of our income will be going to her student debt. We will not be living the "doctor lifestyle". Even our decision to purchase a home as opposed to renting was due to the monthly cost rather than the desire to own. Neither of us has paid a penny of credit card interest ever, and our consumer debt is near 0 (her car being the only exception). Her student loans cost us slightly under 4,000 USD monthly, which is where the bulk of our expenses lie. After 4 years, she will be making a physicians salary, until then, we are under 120k household. – GOATNine Oct 22 at 14:21
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    @GOATNine can't you defer student loans in residency? If so there is your solution. Defer for 2.5 months, use that 4k to pay off the 401K loan, then go back to the loans. – Pete B. Oct 22 at 14:28
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    You can still make payments on deferred loans. If you are worried about risk that is a great option. – Pete B. Oct 22 at 14:49
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    @GOATNine If any of the loans are subsidized, then they won't accrue interest in deferment, and after 2.5 months of paying off the 401k loan you can resume normal payments (or bump them up if possible). Deferment is the best option imo, unless the loan rates are crazy high. – Hart CO Oct 22 at 14:54
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    @stannous yes, because those loans are from before medical school, but they're managed under the same program. – GOATNine Oct 22 at 16:43

I want to note that it is not necessarily have an early withdrawal penalty if you default on your 401(k) loan. Although a default on your 401(k) loan is treated as a withdrawal, it will not be considered a withdrawal if you "rollover" the "withdrawal" into an IRA or to a new 401(k) plan; i.e. if you deposit the amount of the 401(k) loan you defaulted on into an IRA or your new company's 401(k). Normally, you can only make this "rollover" contribution to the IRA within 60 days of the "withdrawal" (unless the government grants you a hardship exception). However, in the 2018 and later tax years, in the case where the loan default was caused by you leaving work, you have until the tax filing deadline, including extensions (October 15 of the following year, if you have an extension; April 15 if you don't have an extension), to make this rollover.

So I would suggest you wait until early next year to see how much cash you have at that time to contribute to this rollover, and only if you still don't have enough money to cover the loan default at that time, do you consider your options above.

  • To avoid the loan being considered an early withdrawal, it will need to be paid in full by Jan 2, 2019. Any amount not repaid by that date will be taxed at our joint income and subject to a 10% penalty. It's interesting to note that the rollover option exists though. – GOATNine Oct 23 at 11:29
  • @GOATNine: "Any amount not repaid by that date will be taxed at our joint income and subject to a 10% penalty." Again, that is not true. You probably got that from the 401k plan saying how much time you have to repay the loan or default. But as I explained above, defaulting on the loan does not mean it will lead to any tax or penalty -- if you rollover the "loan offset" into an IRA or another 401k before the tax filing deadline, including extensions, it is not an "early withdrawal", and there is no tax or penalty. – user102008 Oct 23 at 14:29
  • There is something missing, or it would be standard practice to "rollover" already spent funds into an IRA to avoid the payback period. If I roll from 401(k) distribution to a traditional IRA, I have the same 10% penalty issue. If I roll into a ROTH, I owe taxes on the sum. I can't roll over money that isn't currently in the account though. I would have had to do that first, then disburse the sum. I would still owe the taxes, even if not the penalty. – GOATNine Oct 23 at 14:35
  • @GOATNine: "There is something missing, or it would be standard practice to "rollover" already spent funds into an IRA to avoid the payback period." Well, normally, a rollover must be done within 60 days of the distribution, so it isn't much of an additional period. This is the same for loan defaults prior to 2018. It is a new thing in 2018 that loan defaults due to leaving job have a much longer period to rollover, so maybe this isn't "standard practice" yet. – user102008 Oct 23 at 15:36
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    You should provide a link I can reference. I believe you, and I would 100% take advantage of this if I can, but I can't seem to find any literature on the subject whatsoever, even with regards to political pundits describing/complaining about it. – GOATNine Oct 23 at 16:56

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