Quote:
Originally Posted by kv968
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.
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And step 3 is exactly where everyone gets so confused about this issue. In reality, step 3 is a non-issue. Take my two scenarios through step 3 - but remember, at step 2 both had the same 401k balance. So at step 3 BOTH scenarios will pay exactly the same tax. Also note that, prior to step 3, both scenarios had already paid the same tax - $350 on a $1,000 purchase. It's really just a matter of when that first $350 tax is paid.