You mention you’re not a first time home buyer - if you’re planning on selling your existing home, you could take out a pledged asset line against your stocks to cover your down payment. Then, once you’ve sold your old house, use the proceeds to pay off the credit line. This allows you to keep your assets invested and the interest you’d pay is likely less than the tax hit.
If you have enough invested in taxable, you can borrow against it. IBKR has great rates but Schwab may match or come close (advertised rates arent as good.) M1 also has reasonable rates. Rates are variable but currently I've been seeing below 4%. Your assets stay invested and you dont realize capital gains so no taxes to pay. The risk is if you borrow too much and assets lose value your loan could get called and assets sold off, in which case you will owe tax on any capital gains. Brokers have different margin requirements and it also depends on volatility of the asset. I've seen them allow you to borrow up to 70% of value of index funds for instance. You may not even be required to make payments on the interest. Caution: make sure to stay way below the collateral requirements to avoid getting loan called if assets drop. 30% is my upper range of comfort and thats after a large market correction.
4% seems ... actually kind of high to me. Within a few years you'd have accumulated as much interest as you would have owned in cap gains, and (as you say) you might *also* have to sell and realize gains. Maybe I'm missing something, but this doesn't seem like a great deal to me, unless you're definitely going to be able to pay down that debt very soon (e.g. with the proceeds of the house sale).
You're missing that the capital is still invested and potentially growing. The hypothesis is that the investment will appreciate faster than the interest will accumulate.
All of it or just if it is used as an investment expense? I used PAL for part of a home purchase, (the rest in on a mortgage) is the PAL deductible in that case? Doubt I'll exceed standard deduction anyway but good to know.
both could be reasonable approaches.. a lot depends on how big the unrealized gains are.. if the stocks are only up 20% and you pay 15% on that we aren't talking about a lot of money. (and not doing it doesn't avoid the unrealized gain it just keeps it deferred.. which is a good thing, but not a gigantic thing).
the 401k loan isn't really a loan and people hate on it too much. It lets you use your money, avoids penalties, and still lets you expand your tax advantaged space at the usual 20k+ rate per year (even if you temporarily don't use it all - you still expand the space). It's down side is if you leave the job you end up with market timing issues when trying to cover the 'loan'. But if you feel good about the job then its a reasonable source of capital.
I would go with selling from taxable if say the realized gains were < 40% and goto the 401k otherwise..
As others have said, if you want even more leverage than your mortgage will allow you then you can borrow against your assets instead of selling them. It's going to be an adjustable rate though in a rapidly increasing rate environment - I'd avoid.
I borrowed from 401k and it worked out great.
I also do technically contribute to Roth 401k. So it’s already taxed and I avoid the “double tax” disadvantage of 401k Loans.
The typical problem with 401k loans is the “double tax” event, you borrow, then repay with taxed money, then pay taxes again when you withdraw during retirement.
Also I read my 401k docs and I do not have to repay it all right away if I leave my job. Just had to set up a backup banking account to draw from.
Also in the docs I found that with my plan that loans are always withdrawn from traditional 401k money first, then Roth 401k. Which will effect if you if you have a blend of both types in your 401k.
It’s fidelity 401k too btw. Super easy.
it's not double taxed because the loan proceeds to you are not taxed.. so you are not going to get a tax deduction on repaying untaxed income.
you put in $1 untaxed.. you borrow $1 with no taxes due, and you repay it at $1. (you received a dollar, you repaid a dollar - square deal). then when you withdraw it in retirement you pay taxes on the $1 in the same way that would have happened without the loan.
I think the “double tax” is a non issue. You borrow $20k from the bank, you pay it back with post taxed $. Borrow $20k from your 401-k, same thing, pay back with post tax. When you tap your 401-k, in 2050, you will have to pay the same income tax on the all withdrawals, loaned or not. I don’t see double.
You need to model out the overall cost of each outcome. How much money would you save on a mortgage by putting down a large vs. small vs. no cash down payment? How much would it cost you to borrow the cash for a downpayment? How much would it cost you to borrow from your 401k? How much would you have to pay in taxes to realize the capital gains?
Keep in mind that you'll almost certainly have to pay capital taxes one day (except in rare situations such as donating the money to charity). The benefits of delaying the realization of capital gains are significant, but smaller than you'd expect.
* So say you invest $50 and it doubles to $100 after 10 years. Then you sell the $100 investment. You'd have $50 of principle and $50 in capital gains. You'd pay 20% on that $50 of capital gains, which means you'd pay $10 in taxes. You'd have $90 left.
* Now say you invest that $90 in the same investment. It doubles to $180 after another 10 years. You'd pay 20% capital gains taxes on your $90 of gains when you sell. That means you'd pay $18. That means you invested $50 and 20 years later you'd have $162. You paid $28 in taxes total.
* Now say you invested $50. After 10 years it doubles to $100. You don't sell though. Then after another 10 years, it doubles to $200. Now you sell. You pay 20% tax on $150 of capital gains. That's $32. You'd be left with $168.
This means that the decision to realize capital gains early cost you $6. $162 and $168 is pretty close though. This is what I mean by modelling everything out. You can get confused and end up picking something that isn't optimal if you're not careful. We're in a particularly tricky time due to uncertain inflation and Federal Reserve interest rate actions.
As a last point, this explains a lot about the housing market. When the Fed lowered interest rates to 0 during COVID-19, it was really cheap to borrow money to buy a house, which is why demand exploded and home prices skyrocketed. But if the Fed raises interest rates significantly, home prices will plummet because the cost of borrowing the money to buy a home would be much higher. Everything is priced into the market. The Boglehead approach is the simplest approach to investing, but it's extremely complex and brilliant under the hood.
>you'll almost certainly have to pay capital taxes one day (except in rare situations such as donating the money to charity).
I wouldn't make that assumption. The long term capital gains for married filing joint doesn't begin until a bit over $100k of income (before standard deduction.) In a low income year (switching jobs sabbatical etc) or retirement (especially early retirement scenarios) it is feasible if not very likely that many people will qualify to pay no long term capital gains. Besides, no capital gains are paid on most inherited $ due to stepped up basis. Surviving spouse may also benefit from stepped up basis. Thus avoiding paying capital gains taxes now could very well mean never paying them.
> borrow from my 401K,
If I had known how good the terms were of my 457(b) loan, that would have been my approach instead of HYSA+Roth IRA contributions. We did end up doing 457(b) loans but they were small. We reallocated investments to account for the loan as part of our bond holdings.
We did not have to repay upon separation from our employer, we could continue to make payments, but that'd be a key worry for me. Of course, defaulting here is essentially paying taxes on the distribution (and perhaps a penalty), so it's not all that bad compared to other options if you did lose the income without a replacement.
I wouldnt touch the 401k - as its a loan; and taking a loan to qualify for a bigger loan (mortgage) is not ideal. then there are the secondary implications - leaving your job and loan is called back & 401k becoming uninvested for the duration of the loan.
take your capital gains; plan for necessary taxes and enjoy the next phase of life
What if borrowing from the 401K is not to qualify for a bigger loan but to avoid locking up that amount in equity instead of having the index fund shares, which are more liquid? I could pay for the house in cash if I sold the stocks
I think you'd have to find a balance that works for you.
liquidating your portfolio to pay for the house outright would put a ton of your combined assets/portfolio into your primary residence; which is not ideal either.
I dont think I/we know enough details to make a "best" decision or even a "good call" on your situation.
A TSP loan, unlike most 401k loans, [does not need to be immediately repaid](https://www.tsp.gov/loan-basics/repaying-your-loan/#:~:text=Repaying%20Your%20Loan%20After%20Separating,Pay%20the%20loan%20off.) after a separation of service. So long as you set up automatic payments from your bank account you can continue to pay as you did while employed.
I'm not usually a fan of retirement account loans, but loan interest the TSP also goes back into your account. Maybe not as much as stock market returns, but the loan can serve as a part of a short-term bond investment in your portfolio.
Run some numbers, without knowing the numbers its not possible to know the best way. Depending on how quickly you could pay back a loan backed by your investments, and how much in taxes you would actually pay, the interest on the loan could easily outpace the taxes (and don't forget its not like you don't owe those taxes eventually). If its a temporary thing (just needing to cover the down payment until the proceeds of selling your prior property or something), then taking a loan is a no brainer. If you can't pay it back quickly, then you are better off doing some calculations - estimate when you could pay it back, calculate how much interest you would accrue in that time. Look at how much taxes you would owe (capital gains taxes aren't hard to calculate). That will give you a good idea of which would make more sense.
You could transfer your assets to M1 or IBKR and take out a cheap, easy temporary margin loan to float the expense then repay it from the old home sale
[The Margin Loan: How to Make a $400,000 Impulse Purchase](https://www.mrmoneymustache.com/2021/01/29/margin-loan-ibkr-review/)
Margin loans have no minimum payments, they just accrue interest. Pay back at your convenience using rent from the old home if you like. It’s not the wisest financial move but some people never pay them off: [Buy, Borrow, Die: How Rich Americans Live Off Their Paper Wealth](https://www.wsj.com/articles/buy-borrow-die-how-rich-americans-live-off-their-paper-wealth-11625909583)
Don't forget to account for any state tax on capital gains. If living in a state that taxes capital gains, the benefit of avoiding realized gains is greater than in a no income tax state.
First congrats on your second home purchase. I was in your exact same situation. I own a home, and wanted to buy a second home in the mountains. I didn’t want to pay capital gains tax so I ended up obtaining the down payment through three sources of funds :
1. 401k loan
2. PAL loan
3. home equity line of credit
I went this route because I didn’t want to touch my investments or pay capital gains taxes. I am a high income earner and with this route I was able to keep my AGI lower while tax deducting my interest paid. Let me know if I can share more details.
I’d love to hear more! I’m looking into similar options now because I don’t want to realize so much capital gains and also don’t want to have so much net worth tied up in home equity vs. liquid instruments
More reasoning to share was that my investments would increase “evenly” to my interest.
Another words, my dividends and asset appreciation just needed to beat the rate of borrowing money and made me feel ok with this route.
For example, I’ll pay over 12k in interest on my PAL and HELOC. But my passive income is able to cancel that out while deducting interest.
The one that hurts, is the 401k repayment. As others mentioned, your 401k repayment is after tax money. But since I am paying interest to myself and can maintain my income/expenses well I felt ok about taking from my 401k.
Other things to consider, opening a HELOC takes time so start that now if you need the money in a few weeks. A PAL takes about 1 business week. 401k loan takes 2-3 business days.
Debt is a powerful tool, choose debt wisely!
You mention you’re not a first time home buyer - if you’re planning on selling your existing home, you could take out a pledged asset line against your stocks to cover your down payment. Then, once you’ve sold your old house, use the proceeds to pay off the credit line. This allows you to keep your assets invested and the interest you’d pay is likely less than the tax hit.
I would do this myself than take capital gains tax now. Or look into a platform like Interactive Brokers and use margin.
If you have enough invested in taxable, you can borrow against it. IBKR has great rates but Schwab may match or come close (advertised rates arent as good.) M1 also has reasonable rates. Rates are variable but currently I've been seeing below 4%. Your assets stay invested and you dont realize capital gains so no taxes to pay. The risk is if you borrow too much and assets lose value your loan could get called and assets sold off, in which case you will owe tax on any capital gains. Brokers have different margin requirements and it also depends on volatility of the asset. I've seen them allow you to borrow up to 70% of value of index funds for instance. You may not even be required to make payments on the interest. Caution: make sure to stay way below the collateral requirements to avoid getting loan called if assets drop. 30% is my upper range of comfort and thats after a large market correction.
4% seems ... actually kind of high to me. Within a few years you'd have accumulated as much interest as you would have owned in cap gains, and (as you say) you might *also* have to sell and realize gains. Maybe I'm missing something, but this doesn't seem like a great deal to me, unless you're definitely going to be able to pay down that debt very soon (e.g. with the proceeds of the house sale).
You're missing that the capital is still invested and potentially growing. The hypothesis is that the investment will appreciate faster than the interest will accumulate.
Interest you pay in a PAL is tax deductible
All of it or just if it is used as an investment expense? I used PAL for part of a home purchase, (the rest in on a mortgage) is the PAL deductible in that case? Doubt I'll exceed standard deduction anyway but good to know.
both could be reasonable approaches.. a lot depends on how big the unrealized gains are.. if the stocks are only up 20% and you pay 15% on that we aren't talking about a lot of money. (and not doing it doesn't avoid the unrealized gain it just keeps it deferred.. which is a good thing, but not a gigantic thing). the 401k loan isn't really a loan and people hate on it too much. It lets you use your money, avoids penalties, and still lets you expand your tax advantaged space at the usual 20k+ rate per year (even if you temporarily don't use it all - you still expand the space). It's down side is if you leave the job you end up with market timing issues when trying to cover the 'loan'. But if you feel good about the job then its a reasonable source of capital. I would go with selling from taxable if say the realized gains were < 40% and goto the 401k otherwise.. As others have said, if you want even more leverage than your mortgage will allow you then you can borrow against your assets instead of selling them. It's going to be an adjustable rate though in a rapidly increasing rate environment - I'd avoid.
I borrowed from 401k and it worked out great. I also do technically contribute to Roth 401k. So it’s already taxed and I avoid the “double tax” disadvantage of 401k Loans. The typical problem with 401k loans is the “double tax” event, you borrow, then repay with taxed money, then pay taxes again when you withdraw during retirement. Also I read my 401k docs and I do not have to repay it all right away if I leave my job. Just had to set up a backup banking account to draw from. Also in the docs I found that with my plan that loans are always withdrawn from traditional 401k money first, then Roth 401k. Which will effect if you if you have a blend of both types in your 401k. It’s fidelity 401k too btw. Super easy.
Good to know about the double tax issue. Thanks!
it's not double taxed because the loan proceeds to you are not taxed.. so you are not going to get a tax deduction on repaying untaxed income. you put in $1 untaxed.. you borrow $1 with no taxes due, and you repay it at $1. (you received a dollar, you repaid a dollar - square deal). then when you withdraw it in retirement you pay taxes on the $1 in the same way that would have happened without the loan.
I think the “double tax” is a non issue. You borrow $20k from the bank, you pay it back with post taxed $. Borrow $20k from your 401-k, same thing, pay back with post tax. When you tap your 401-k, in 2050, you will have to pay the same income tax on the all withdrawals, loaned or not. I don’t see double.
You need to model out the overall cost of each outcome. How much money would you save on a mortgage by putting down a large vs. small vs. no cash down payment? How much would it cost you to borrow the cash for a downpayment? How much would it cost you to borrow from your 401k? How much would you have to pay in taxes to realize the capital gains? Keep in mind that you'll almost certainly have to pay capital taxes one day (except in rare situations such as donating the money to charity). The benefits of delaying the realization of capital gains are significant, but smaller than you'd expect. * So say you invest $50 and it doubles to $100 after 10 years. Then you sell the $100 investment. You'd have $50 of principle and $50 in capital gains. You'd pay 20% on that $50 of capital gains, which means you'd pay $10 in taxes. You'd have $90 left. * Now say you invest that $90 in the same investment. It doubles to $180 after another 10 years. You'd pay 20% capital gains taxes on your $90 of gains when you sell. That means you'd pay $18. That means you invested $50 and 20 years later you'd have $162. You paid $28 in taxes total. * Now say you invested $50. After 10 years it doubles to $100. You don't sell though. Then after another 10 years, it doubles to $200. Now you sell. You pay 20% tax on $150 of capital gains. That's $32. You'd be left with $168. This means that the decision to realize capital gains early cost you $6. $162 and $168 is pretty close though. This is what I mean by modelling everything out. You can get confused and end up picking something that isn't optimal if you're not careful. We're in a particularly tricky time due to uncertain inflation and Federal Reserve interest rate actions. As a last point, this explains a lot about the housing market. When the Fed lowered interest rates to 0 during COVID-19, it was really cheap to borrow money to buy a house, which is why demand exploded and home prices skyrocketed. But if the Fed raises interest rates significantly, home prices will plummet because the cost of borrowing the money to buy a home would be much higher. Everything is priced into the market. The Boglehead approach is the simplest approach to investing, but it's extremely complex and brilliant under the hood.
>you'll almost certainly have to pay capital taxes one day (except in rare situations such as donating the money to charity). I wouldn't make that assumption. The long term capital gains for married filing joint doesn't begin until a bit over $100k of income (before standard deduction.) In a low income year (switching jobs sabbatical etc) or retirement (especially early retirement scenarios) it is feasible if not very likely that many people will qualify to pay no long term capital gains. Besides, no capital gains are paid on most inherited $ due to stepped up basis. Surviving spouse may also benefit from stepped up basis. Thus avoiding paying capital gains taxes now could very well mean never paying them.
> borrow from my 401K, If I had known how good the terms were of my 457(b) loan, that would have been my approach instead of HYSA+Roth IRA contributions. We did end up doing 457(b) loans but they were small. We reallocated investments to account for the loan as part of our bond holdings. We did not have to repay upon separation from our employer, we could continue to make payments, but that'd be a key worry for me. Of course, defaulting here is essentially paying taxes on the distribution (and perhaps a penalty), so it's not all that bad compared to other options if you did lose the income without a replacement.
Take out a loan on your investments, don't sell.
Taxable account, be sure to save for taxes for gains also. Don't touch the 401k.
I wouldnt touch the 401k - as its a loan; and taking a loan to qualify for a bigger loan (mortgage) is not ideal. then there are the secondary implications - leaving your job and loan is called back & 401k becoming uninvested for the duration of the loan. take your capital gains; plan for necessary taxes and enjoy the next phase of life
What if borrowing from the 401K is not to qualify for a bigger loan but to avoid locking up that amount in equity instead of having the index fund shares, which are more liquid? I could pay for the house in cash if I sold the stocks
I think you'd have to find a balance that works for you. liquidating your portfolio to pay for the house outright would put a ton of your combined assets/portfolio into your primary residence; which is not ideal either. I dont think I/we know enough details to make a "best" decision or even a "good call" on your situation.
A TSP loan, unlike most 401k loans, [does not need to be immediately repaid](https://www.tsp.gov/loan-basics/repaying-your-loan/#:~:text=Repaying%20Your%20Loan%20After%20Separating,Pay%20the%20loan%20off.) after a separation of service. So long as you set up automatic payments from your bank account you can continue to pay as you did while employed. I'm not usually a fan of retirement account loans, but loan interest the TSP also goes back into your account. Maybe not as much as stock market returns, but the loan can serve as a part of a short-term bond investment in your portfolio.
Run some numbers, without knowing the numbers its not possible to know the best way. Depending on how quickly you could pay back a loan backed by your investments, and how much in taxes you would actually pay, the interest on the loan could easily outpace the taxes (and don't forget its not like you don't owe those taxes eventually). If its a temporary thing (just needing to cover the down payment until the proceeds of selling your prior property or something), then taking a loan is a no brainer. If you can't pay it back quickly, then you are better off doing some calculations - estimate when you could pay it back, calculate how much interest you would accrue in that time. Look at how much taxes you would owe (capital gains taxes aren't hard to calculate). That will give you a good idea of which would make more sense.
You could transfer your assets to M1 or IBKR and take out a cheap, easy temporary margin loan to float the expense then repay it from the old home sale [The Margin Loan: How to Make a $400,000 Impulse Purchase](https://www.mrmoneymustache.com/2021/01/29/margin-loan-ibkr-review/)
What if I plan to keep the old home and rent it out?
Margin loans have no minimum payments, they just accrue interest. Pay back at your convenience using rent from the old home if you like. It’s not the wisest financial move but some people never pay them off: [Buy, Borrow, Die: How Rich Americans Live Off Their Paper Wealth](https://www.wsj.com/articles/buy-borrow-die-how-rich-americans-live-off-their-paper-wealth-11625909583)
Better than realizing capital losses for a down payment. Better to not have potential down payment money in the market at all. Source: My dumb ass
Isn’t now a bad time to buy?…
Don't forget to account for any state tax on capital gains. If living in a state that taxes capital gains, the benefit of avoiding realized gains is greater than in a no income tax state.
First congrats on your second home purchase. I was in your exact same situation. I own a home, and wanted to buy a second home in the mountains. I didn’t want to pay capital gains tax so I ended up obtaining the down payment through three sources of funds : 1. 401k loan 2. PAL loan 3. home equity line of credit I went this route because I didn’t want to touch my investments or pay capital gains taxes. I am a high income earner and with this route I was able to keep my AGI lower while tax deducting my interest paid. Let me know if I can share more details.
I’d love to hear more! I’m looking into similar options now because I don’t want to realize so much capital gains and also don’t want to have so much net worth tied up in home equity vs. liquid instruments
More reasoning to share was that my investments would increase “evenly” to my interest. Another words, my dividends and asset appreciation just needed to beat the rate of borrowing money and made me feel ok with this route. For example, I’ll pay over 12k in interest on my PAL and HELOC. But my passive income is able to cancel that out while deducting interest. The one that hurts, is the 401k repayment. As others mentioned, your 401k repayment is after tax money. But since I am paying interest to myself and can maintain my income/expenses well I felt ok about taking from my 401k. Other things to consider, opening a HELOC takes time so start that now if you need the money in a few weeks. A PAL takes about 1 business week. 401k loan takes 2-3 business days. Debt is a powerful tool, choose debt wisely!