I took out a $22,000 loan (over 7 years) against my 401(k) for the purchase of a new home. I currently owe $15,000 on that loan. While I make 401(k) contributions each paycheck, I am not making the max contribution. Does it makes more sense to prioritize repaying the 401(k) loan (with post-tax earnings), resulting in a smaller 401(k) contribution? Or, should I prioritize making larger 401(k) contributions (with pre-tax earnings) and not attempt to pay off the remainder of the 401(k) loan early?
No. Probably not.
As far as losing your job is concerned -
You get until tax day the following year to replace the amount — i.e., if you are laid off in April 2020, you get until April 15, 2021, to come up with the funds. Prior to major tax law changes that took effect in 2018, participants only had 60 days.
Although most plans won’t let you continue paying the loan after you leave the company, it’s worthwhile checking on the policy for your 401(k) plan.
The issue regarding how your money is invested is interesting. Say you are paying the loan at 5%. That 5% is going into your account. The cash/bond portion of my own 401(k) has been under 2% for some time now. You have the benefit of a low interest loan (which those who pay 18% on a credit card would envy, along with a retirement account earning 6.25% in the safe portion.
At least Ben agrees to maximize the matched deposits. Once that's done, the choice is personal. I can contrive a scenario where either result is far better than the other. One thing to clarify. There are some 401(k) accounts that have one provision, "no match while a loan is outstanding". If that's the case, I'd pay it off ASAP.
UPDATE: The facts, The loan is 6.25%, combined with OP already maximizing matched deposits, would have me lean towards just paying it off more quickly. As long as he has enough liquidity (emergency fund) and no other high interest undisclosed debt.
Soapbox: There are too many bits of tax code that are broken, in my opinion. The ability to borrow from a 401(k) is (I agree with Ben here) super risky*. As Ben has identified, the loss of a job can, depending on the plan, destroy one's savings. This needs fixing. There is no risk to the employer to maintain the loan, after all, they have your money. Easy enough to update the tax code to permit this, along with a provision that the new company you work for should move the 401(k) along with the loan.
*For the average borrower. You may be in a different group, by the reason you took the loan, and by the level of awareness just by visiting here and asking the question.
Yes, in my opinion, you should be paying that loan off ASAP.
One big reason is that if you leave your job for any reason, the loan will be due in full sometime within a year or so. If you cannot come up with the money, it will be treated as a 401(k) early withdrawal, with all the associated taxes and penalties.
One thing that not everyone understands about 401(k) loans is that the money you have out in the loan is no longer invested in the 401(k). The interest that you are paying does go into your own 401(k) as you pay it back, but this interest is coming from your own pocket.
The employer match does come into play here, as your future contributions are subject to the match, but your loan repayments are not. So it probably does make sense to try to get as much match as you can, but it is still in your best interest to clear this loan as quick as you can to get your money invested again and eliminate the obligation that you have to your current employer.