401k / 403b loans cause double taxation?

[GoodSteward]

This came up in another thread, but I didn't want to take away from what the OP was asking about. Someone mentioned how borrowing from a retirement plan that was pretax, and then replacing that money in the form of post tax dollars causes you to pay taxes twice on the same money. Others disagree.


I am curious what people think about this.

[GoodSteward]

What I found out personally is that this type of loan isn't borrowing against your retirement plan, you are actually removing that money from the market. Basically, you are getting to cash in on that money without officially counting as withdrawing it, because you are paying it back. When you do pay it back it comes out of the post-tax withholdings part of the check. This is from my own personal experience from borrowing against my 401k ONCE. Never again.

With that in mind, I can see how this could technically make money you pay the loan back with(already taxed) be taxed again when you withdraw. You are not simply repaying money that you borrowed from someone else, you are putting money back into the market. It doesn't even out by just paying it back because your payments have no tax benefit. I guess that is why it is designed to pay you back with the interest.

I don't think this is a large sum of money we are talking about in taxes, but I guess if the loan is big enough it could be. That coupled with the loss of earnings, these things do add up quickly. Never borrow from retirement.

Petunia100 mentioned 1-1+1=1 not 2. This is correct as far as 1s go, but technically it isn't all 1s. It is more like 1a-1a+1b=1b or 1taxfree-1taxfree+1tax=1tax. Algebra, blah... This is not something I've actually worked out so I could be wrong because of some weird special math reasons. I'm not above that.

[GoodSteward]

I feel like this kid right about now.

[HundredK]

It is not double taxation. That is a myth, as I said (several times) in the other post. Here's a link that might help:

https://thefinancebuff.com/401k-loan-double-taxation-myth.html

and this: http://www.investopedia.com/articles...-401k-loan.asp

[GoodSteward]

Ok, I felt like something was stil missing. Looking at it a little closer you are double taxed on the interest you pay in(to yourself), not the entire amount.

Depending on the reason, amount, and length of time for the loan it can be a better option vs a traditional loan if you had to reduce your 401k payments to pay back the loan. I still don't recommend it because it is too easy to tap into same as someone who uses a credit card and rolls the balance.

[disneysteve]

you are double taxed on the interest you pay in(to yourself), not the entire amount.

Okay, so the double taxation thing isn't totally wrong.

I need to review this more when I have time because honestly I still have a little trouble explaining why the money you take out isn't being taxed twice.

You borrow money that hasn't been taxed yet.
You pay it back with money that has already been taxed.
In retirement, you then withdraw that money and pay tax on it again.

I realize I'm missing something. I just need to read one of the articles that walks through it and explains why that isn't true.

I still don't recommend it because it is too easy to tap into same as someone who uses a credit card and rolls the balance.

When you look at the stats of the average 401k balance and the percentage of folks who have outstanding loans from their 401k, you see that this is a problem. People don't look at their retirement accounts as being for retirement. They view them as just another pool of money to be spent for whatever. The % of workers who cash out their 401k when they leave a job is also way too high. Lots of people are going to be in deep trouble when they get to retirement - if they are ever able to actually retire.

[GoodSteward]

Okay, so the double taxation thing isn't totally wrong.

I need to review this more when I have time because honestly I still have a little trouble explaining why the money you take out isn't being taxed twice.

You borrow money that hasn't been taxed yet.
You pay it back with money that has already been taxed.
In retirement, you then withdraw that money and pay tax on it again.

I realize I'm missing something. I just need to read one of the articles that walks through it and explains why that isn't true.

I believe what we were missing is that we are using the money tax-free that we are pulling out in place of money we would have used for taxes, so it evens out. Basically, we are just advancing ourselves money that we would have spent anyway that was post tax.

You borrow 10k$ to pay off a credit card with tax-free money, and then you put the money back as payments that are taxed vs paying off the credit card with payments that are taxed. You are paying off the credit card with taxed money regardless, but just adding the tax-free money into the mix to get it off the card.

From what I can tell the only new money being introduced into the whole equation is the interest you are paying. That is taxed money being added into the account that will be taxed again, however, due to you paying interest to yourself it can easily offset the negative of that. In one of those articles on a 10,000$ loan at 4% for 1yr, the figure was only about 80$ total "double taxation" once you factored in the interest you are paying yourself. It all depends on the tax rate, interest rate, and length of the loan.

When you look at the stats of the average 401k balance and the percentage of folks who have outstanding loans from their 401k, you see that this is a problem. People don't look at their retirement accounts as being for retirement. They view them as just another pool of money to be spent for whatever. The % of workers who cash out their 401k when they leave a job is also way too high. Lots of people are going to be in deep trouble when they get to retirement - if they are ever able to actually retire.

That's right. It isn't always about the best numbers on paper. Bad habits can cause a lot more harm than one bad loan. I know someoen who borrows from a local loan company at 20+% and pays it down to a point, and then borrows up to the original amount again every year. What amazes me is how easily people get sucked into these kinds of situations, but if you talk to them up front about saving for something or putting money aside for something they can't aford to. But they can afford that payment? Smh

[LivingAlmostLarge]

It's like friends who tell me they have no CC debt. But then say oh we need our bonus check once a year to clear their CC debt. Because during the year they let it run up and count on their bonus check to clear it off.

[GoodSteward]

It's like friends who tell me they have no CC debt. But then say oh we need our bonus check once a year to clear their CC debt. Because during the year they let it run up and count on their bonus check to clear it off.

I have a friend who did that for several years using their tax return. They would spend several thousand on mess, especially sports and Christmas, and then use taxes to pay it off. A couple years ago it caught up because they charged more than they could pay off. Now they are rolling a lot of debt.

They used to make fun of me and the situation I was in for years with a lot of credit card debt. I got out of it, and now they are in it. What goes around comes around. Don't judge someone based on past mistakes, pay attention to their current choices to determine what you think of them.

[disneysteve]

I have a friend who did that for several years using their tax return.

I will never quite understand all of the people who view their tax refund as some magic bonus money. They just don't seem to understand that it isn't some special gift from the government. It is their very own money that they voluntarily overpaid in taxes being returned to them (with no interest, of course). They see it as a windfall.

Of course, I also know some people who understand exactly what a tax refund is but they view it as a forced savings plan and do it with that in mind.