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A 401(k) "Margin Call"

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Question: My former employer has gone into receivership and I was informed that they will be terminating their 401k program. I would have rolled my 401k over into an IRA a year ago had it not been for a personal loan I took out against it. The outstanding balance is about $9,000.00, or about 35% of the value of the account. (A side note, last year, the loan was, in fact, outperforming most of the other elements of the plan!)

According to the letter I received from the financial services group involved, my options are:
1) Pay off the loan, which is possible, if I tap my home equity, and roll the whole thing into an IRA. or …
2) Deduct the outstanding balance from the 401k, roll over the un-leveraged balance into an IRA, and pay taxes on the loan amount.

I do have an open line of credit with my bank against my house, with a zero balance, that I could use to avoid the tax consequences.

What would you do? It kind of feels like a margin call, and right now, I could ring my former employer’s neck.

Thanks!

Answer: I don’t blame you for being upset. You did get the equivalent of a “margin call.” You borrowed money to invest, and now the bill is coming due quickly. By the way, I have to say that I am not a fan of borrowing money to invest. I think leveraging up a portfolio like that is too risky for most people. What’s more, although I hear the “mantra” that when you borrow from your 401(k) you’re borrowing from yourself, I don’t find the idea persuasive. It’s still an expensive loan.

That said, what do I think is your best option? I would choose to pay off the loan by borrowing on the home equity line of credit–with this critical caveat: That you can repay the loan quickly. If the answer to that is “yes,” it’ll allow you to roll the whole amount in your 401(k) into an IRA and avoid an income tax hit, as well as the 10% penalty to Uncle Sam.

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