One of the often quoted “nice things” about a 401(k) is the fact that you can borrow from your 401(k) up to $50,000 or 50% of it’s current assets. What’s nice about that is the fact that while you do pay interest, you’re paying it to yourself so it is in effect an interest free loan, right?
Wrong! What you are borrowing are pre-tax dollars that you contributed through a deduction from your paycheck but what you are paying back with are post-tax dollars plus interest. This money will be taxed once again when you start taking disbursements from your 401(k) during retirement… so the dollars you are paying yourself back with will be taxed twice.
Don’t ever ever ever borrow from your 401(k).
Comments
3 responses to “Don’t Borrow From Your 401(k)”
I love my dad, but he hasn’t made the best financial decisions during his life. The most recent blunder that he made was exactly what you’re advising against. He used it to pay off his mortgage, so it didn’t go to waste, but it was a poor choice for the reasons you’ve outlined. There was no convincing him (even after the fact) that it was the wrong move, but what can you do? What I’ll do is not make the same mistake he did.
You aren’t really being taxed twice on the principal of the loan. You can take money out, put in a bank account, and use that same money to later pay back your loan. This money is not after-tax, it is the same exact money you took out in the first place.
The interest is double-taxed because you do have to use after-tax money to pay that back. However, the original money you withdrew is allowing you to earn interest on some money that would have otherwise gone to the government in the form of income tax payments, so it’s like an interest free loan of “government tax dollars”. The double-taxation on the interest is really paying back the government for the benefit you received from borrowing “their” tax dollars to spend today.
Your logic is flawed.
One is simply replacing pre-tax dollars that were taken out of the 401(K)and used for some purpose. The benefit is that you get more dollars to work with than if tax had been paid on these dollars to begin with.
You are replacing the dollars with dollars. You may or may not have paid tax on the dollars you are putting back. But even if you did (which is the case for most of us), you are simply replacing the tax free dollars that you borrowed.
So in the end the dollars that you take out of the 401(K)for retirement purposes will be taxed. But taxed only once, just as if they were in there all along and never taken out(borrowed) for some other use.