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Ruminant t1_j2crs6p wrote

Reply to comment by HenryKringle6000 in Personal Loan Against 401k to Contribute More? by [deleted]

This is a common misconception. There is no double-taxation of the money used to repay the principal.

The simplest way to prove this to yourself is to imagine paying back a 0% interest 401(k) loan from the same dollars that are initially disbursed by the loan. Those dollars were not taxed going into the 401(k), they were not taxed when they came out as a loan, and they are not taxed going back into the 401(k). So where is the double taxation?

Since dollars are fungible, the same conclusion above can be applied to any other dollars which pay back 401(k) principal.

You are double-taxed on the interest paid to a pretax 401(k) loan. But because the actual interest goes back into your balance, that extra taxation becomes the only effective "cost" of a pretax 401(k) loan. This tends to not be a big cost as far as loans go. For example, the double-taxation of a 8.5% loan from a pretax account by someone with a 27% marginal tax rate works out to an effective interest rate of 2.3%. That's not terrible.

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HenryKringle6000 t1_j2cs0yu wrote

Yes, there is double taxation.

You put the dollars in tax free. You pull them out. You put them back in as post-tax dollars.

Then you pay tax again when you retire and pull the money out of your 401k.

That’s double taxation.

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Ruminant t1_j2csmaj wrote

How are you putting them in as "post-tax" dollars if you are literally using the same pretax dollars that were dispersed as the original loan principal? When are they ever taxed, other than when withdrawn in retirement?

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HenryKringle6000 t1_j2ct2dm wrote

Let’s say you put $10k pre-tax dollars into your 401k.

Then you take a $10k loan out. The loan repayments come out of the post-tax part of your paycheck. Aka, now you are putting taxed dollars back into the 401k to replace the pre-tax dollars you took out.

When your loan is over you put in $10k to repay the loan… but it was no longer tax free. The repayments weren’t pre-tax dollars. You paid taxes on those dollars.

Now, when you retire and pull the 401k money out you will pay tax on that $10k again. That’s double taxation.

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[deleted] OP t1_j2ct9w2 wrote

[deleted]

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HenryKringle6000 t1_j2ctny8 wrote

I guess I don’t understand why you would want to do that. The only benefit of these ROTH/401k plans is to save on taxes. And the government puts strict limits on them.

Why not just put any excess money you want to invest in normal stock account?

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Ruminant t1_j2cucsc wrote

Imagine that you never spend the $10k disbursed by the loan. Then for every dollar of principal that you repay via payroll deduction, you transfer a dollar from the original loan amount into the bank account where your paychecks are deposited.

How would that above scenario look different from one where you could instead make loan repayments from the original principal rather than payroll deduction? It wouldn't. Your bank account would have the same ending balance, and you'd see the same amount of taxes being withheld (and ultimately taxed) from each paycheck.

How can you be double-taxed if the money used to repay the principal is never once taxed until you withdraw it in retirement?

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