I took out a loan from my 401k for primary residence purchase and deal fell through. What can I do with the money now other than paying it all back to pay off the loan.(and lock that money up for 12 months) Can I use it for other purposes? Can I use part of it to pay back another 401k non-prin. Res. Loan? Can it be converted to a non-prin. Res. Loan? It is with Vanguard. I would rather keep the new loan and pay off the old loan because the new one is for a longer term with lower payments.
Thanks, Wayne

Wayne:

If you use it for OTHER purposes, you are technically in violation of the loan agreement and the tax law.

However, what Vanguard and the IRS does not know will not hurt them. If I were in your place, I would pay off the other 401K loan, bank the difference and make sure you make all payments on time.

You want to bank the difference because, if you should lose your job, you would have to pay that loan back immediately or the loan becomes an EARLY DISTRIBUTION, which is subject to state and federal income taxes PLUS a 10% Early Distribution Penalty.

If you don't really need the loan, I would strongly suggest paying as much of the 401(k) loan back ASAP, as opposed to banking it for a rainy day. The interest rate on the loan may look attractive, but remember that (1) the interest payment is not tax-deductible (since you are paying yourself) - so unlike a normal 401(k) contribution you have no tax advantage, (2) as long as you have a loan outstanding you can't make any additional contributions to your 401(k), so you are falling behind in your retirement planning, and (3) down the road once you start making retirement withdrawals the interest that you paid in is considered earnings by the 401(K), and so when you withdraw that interest money is is taxed as ordinary income. In other words, you get to pay income taxes twice on the interest amount!

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Originally Posted by ebaines

(2) as long as you have a loan outstanding you can't make any additional contributions to your 401(k), so you are falling behind in your retirement planning,

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Um, What? Why can't you make contributions? I have an outstanding loan and am continuing to make contributions as well. I've done this on three different 401Ks.

Did the loan papers specifically state that this was for a primary residence? Most 401K loan provisions don't require a reason for a loan. However, if the loan was specific for this purpose then I would pay it back. It won't be hard for the IRS to note you didn't change addresses. If it didn't specify, then you can do what you want with it.

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Originally Posted by ScottGem

Um, What?? Why can't you make contributions? I have an outstanding loan and am continuing to make contributions as well. I've done this on three different 401Ks.

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ScottGem - you're right, thanks for the correction. What I should have said is that most people reduce or stop their contributions while they have a loan outstanding, since it can be difficult to afford funding both the regular contribution and the loan payback (which is automatically deducted from their paycheck) at the same time. But you are correct - there is no requirement to stop contributions while the loan is outstanding. My bad.

No comments!

I'm wondering what the ramifications might be if I paid the other loan off and then used the balance for the home purchase. That way I would only have 1 loan out and would still have some of the money to use for the home purchase. I initially planned to use it all for the purchase and then pay off the first loan with the proceeds from the sale of the current house. Why does the IRS really care what I do with it?
Wayne

Another vote for putting it back to your 401k account.

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Originally Posted by ppauto

Why does the IRS really care what I do with it?
Wayne

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Again I ask whether the loan was done specifically as a home purchase loan. I not sure if there is anything in the tax code that differentiates one 401K loan from another. But plans can write in their own restrictions on loans.

As to why the IRS cares, its because they are allowing you to contribute pre tax dollars to the plan with the understanding its to be used for retirement. Therefore, if you use that money for anything else but retirement, they have a say in it. The IRS code permits 401K loans, because it requires that the loans be paid back with interest that goes back into the plan. So, even though you are using the money, its still earning income (the interest). So it doesn't compromise the purpose of the 401K.

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Originally Posted by ppauto

Why does the IRS really care what I do with it?
Wayne

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Actually the IRS may not care at all. There is no requirement in law that 401(k) loans must be used for any specific purpose - that's strictly up to the particular provisions of your company's plan. Many companies put no restrictions on the purpose of the loan at all; others limit loans to only a few specified uses. Most plans use a 5-year payback schedule for loans, but some allow for a longer payback if the stated purpose is to purchase a home. So I guess the danger here is that if you use the loan money for something other than the purpose you stated, you could be in violation of the plan's rules. I have no idea what the consequence would be - I suggest you call the plan admin and ask, so as to avoid any nasty surprises.

See ebaines answer #10. I didn't think there was anything in the code that defined the purpose of the loan. So the IRS probably won't care. However, the plan could CALL the loan if they found it wasn't being used for the stated purpose, especially if there were special terms (lower interest, longer term)allowed for such loans.

Yes, the plan rules say that I can have 1 pri. Res. Loan and 1 non-pri.res loan at any given time. The paperwork with the pri.res loan stated that it could not be used for purposes other that acquiring a primary residence. However, Vanguard would never know what I use the money for unless I tell them. I just want to make sure there wouldn't be any IRS trouble if I pay off the non-pri. Res loan with it and save the rest for home purchase or whatever else I might use it for in the event I never sell my house and buy another one. All of your answers have been helpful. I appreciate everyone who has taken the time to respond to my questions.
Thanks, Wayne

So what happens if Vanguard (or the company) notices you haven't changed addresses. They could CALL the loan, meaning you have to pay it back or it will be considered an inservice withdrawal with the attnendant penalties. Do you want to risk that?

I just spoke to Vanguard about these questions. The person there told me that the IRS isn't notified that the loan exists unless it goes into default. Also, once the proper paperwork is submitted for the primary residence loan and it is approved, Vanguard is no longer concerned about what is done with the money.
I believe I will pay off the first loan (the non-pri. Res. One) and sit on the balance until the house deal comes through. Thank you for your help everyone.
Wayne

Ok, If that's the case, then you can do what you want. My only concern was Vanguard calling the loan.

The custodian VERY RARELY calls in such loans. It is NOT good customer relations.