Quote:
Originally Posted by humandraydel
Well, you are forgetting that the money loaned to you was TAX FREE. I'll try to explain, but it seems most people have difficulty understanding this.
Imagine you want to spend $1,000 on a plasma TV. You have two options (assume 25% tax bracket):
1. Make $1,350 dollars resulting in ~$1,000 after taxes. Buy TV.
2. Take out 401k loan for $1,000. Buy TV. Repay 401k by making $1,350 pre-tax dollars.
Either way, you must make $1,350 pre-tax dollars to pay for a $1,000 after tax dollar expense. Also, in both scenarios your 401k balance does not change.
Alternatively, consider the scenario in which you borrow $1,000 from your 401k to buy a TV. Being the frugal person you are, you decide to wait a week and see if your desire subsides  After a week you decide you don't need the TV, and repay the $1,000 401k loan. You incurred no extra taxes by doing this. |
Nice analogy, but you didn't take it out quite far enough. I understand what you're saying, but you're not taking into consideration the tax you pay on the money you take out of the 401k when you retire.
1. You borrow $1,000 from your 401k
2. You pay back the $1,000 loan with $1,350 pre-tax since it'll be out of post-tax money(assuming 25% tax bracket and not worrying about the interest)
3. When you take out that $1000 later when you retire you are taxed on it as normal income.
Step #3 is when the double taxation comes into play. You were taxed on that money in step #2 before you paid back the loan with it and now again in step #3 when you take it out in retirement.
The amount in your 401k also changes. Take $1000 dollars out, and that's $1000 less in your 401k until you pay it back.
The alternative scenario is correct though because you're paying the money back with the same money you took out without getting anything for the money. You didn't use it for anything so there's no transfer of goods. For example, you give me 10k and I give it right back to you. I gain nothing from that transaction because I didn't get anything from it. If you give me 10k and I buy something with it, the money's gone, the product or whatever is mine but now I have to come up with 10k to give you. And that 10k will be money I made after taxes were taken out. The only difference in this scenario is you won't be giving that 10k back to me in retirement where it will get taxed again. Although you could if you'd like
And besides, the desire wouldn't subside with a plasma TV
