Is it ever advisable to borrow from my line of credit to contribute to my 401(k)?

Is it ever advisable to borrow from my line of credit to contribute to my 401(k)?

by Thomas N. Alvaré, CPA | Feb 26, 2018

If your 401(k) returns exceed the cost of borrowing the funds, then it could be advisable to borrow funds from a line of credit. Determining this potential outcome warrants further discussion, though.

In terms of cash flow, 401(k) contributions come from payroll deduction, usually in even amounts per paycheck. So loan proceeds cannot typically be placed directly into a 401(k) account. Line-of-credit withdrawals could replace a reduced take home pay from increased 401(k) contributions, however. Because 401(k) contributions are not subject to federal income tax withholding. By adding $1,000 to a 401(k) on a pretax basis, federal withholding will also decrease by about $200 (actual withholding rates vary at different income levels), so in this example net pay will go down by just $800 to fund the $1,000 401(k) contribution. Borrowing $800 to replace reduced take-home pay while adding $1,000 to a 401(k) would be the key advantage. The extra $200 remains invested and also enjoys the benefits of compounding over time.

At some point, however, the line of credit needs to be repaid. As long as this repayment process does not lead to reducing 401(k) contributions (reversing the flow in the example above) it could remain advantageous. If repayment later comes from other funds, or even later 401(k) withdrawals (after age 59.5), the advantages can still be captured as a result of financial “leverage.” If the interest rate on the line of credit is, say, 4 percent, then the after-tax rate of return on the 401(k) would need to be greater than 4 percent (interest cost) to work out favorably.

As we all know, investing involves risk and fluctuations in values. There are periods of time where a well-diversified 401(k) account will earn less than 4 percent (or the loan interest rate). However, with a healthy allocation to equities of 60 percent or more and a longer period of time for the 401(k) to grow (5 years or longer), the odds are good that the financial leverage of borrowing to allow for increased 401(k) funding will be advantageous.

For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: Thomas N. Alvaré, CPA, is managing principal with JFS Wealth Advisors in Doylestown, Pa.

The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
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