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avalpert t1_j2e5sbi wrote

No, that doesn't make sense. You'll be turning what would have been tax-free growth into taxable growth only to put it back in the same account that would have been tax free.

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HenryKringle6000 t1_j2cp30t wrote

No. Taking out a 401k loan is almost always a bad option. They seem like a good deal … you borrow money from yourself and pay yourself interest.

Here’s the catch… you put money into the 401k pre-tax and then you pay tax when you eventually pull it out many years from now. When you pull out the loan from your 401k that is not taxable. But, the money you are using to pay back the 401k loan is post tax dollars.

Aka, you end up paying taxes TWICE on the same dollars. That’s very very expensive.

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Ruminant t1_j2crs6p wrote

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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nip9 t1_j2crz1u wrote

You only pay taxes twice on the interest portion. There is no double taxation on the principal of a 401k loan. You are missing that the loan distribution itself converts pre-tax to post tax so the dollars you take out equal the dollars you repay plus a little interest.

Now the interest amount would be post tax dollars that are later taxed again whenever the money is eventually withdrawn. That is a tiny disadvantage since one is paying interest to themselves.

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HenryKringle6000 t1_j2csdve wrote

You pay taxes twice. Once by paying the loan back in post-tax dollars. And again when you retire and pull the money out of your 401k.

That’s double taxation.

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avalpert t1_j2e64u0 wrote

You are mistaken because you are forgetting that the dollars you got as a loan are treated as post-tax dollars.

Look at it this way, take out a loan for $10k, immediately pay it back with that same $10k - did you convert them into 'double-taxed' dollars, of course not.

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nip9 t1_j2e6rvq wrote

You borrow $10k from your 401k and what exactly do you believe occurs?

$10k is subtracted from your pre-tax dollar 401k balance and $10k in post-tax dollars get deposited in your bank account. Pre-tax dollars have been converted to post-tax dollars without a taxable event occurring (assuming the loan is paid back in full and doesn't become an early distribution).

You repay that loan with an equal $10k amount of post-tax dollars plus interest.

No double taxation on the principal because you received post-tax dollars and repaid post-tax dollars.

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