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401(k) Loan Repayments as "pre-tax"?

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11 replies to this topic

#1 jkharvey


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Posted 30 June 2004 - 03:16 PM

A client of ours is telling us that loan payments made through payroll deduction are made "pretax" just like a 401k deferral. The client has said that she "researched" the issue and we are asking for her research but I wanted to know if anyone else has heard of this.

#2 rmeigs


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Posted 30 June 2004 - 03:39 PM

Interesting concept, but since a loan payment is the returning of contributions already deferred (plus interest income), I can't see how the client could construe that a loan payment would be another pretax deferral. I’d press them for their “documentation” on this.

#3 Demosthenes


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Posted 30 June 2004 - 03:51 PM

Yep and the IRS is fully aware of it and doesn't care although maybe not in the sense that you would think.

Assume that a participant takes a loan from a 401(k) plan (no after tax dollars) and repays via payroll deduction. There is no provision to exempt loan repayments from withholding. Thus, the repayments are made from after tax dollars into a pre tax account and will be taxed a second time at distribution. In a sense they become pre tax without the benefit of an exemption from payroll taxes.

It's not stated, just inherent in the regs, the IRS is fully aware of it, their response has been "Too bad, so sad!".

#4 Brenda Wren

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Posted 30 June 2004 - 04:17 PM

Loan repayments CANNOT be pre-taxed! If they could, we'd all be doing it! Demosthenes, I think you misunderstood the original question. And, by the way, the only money that is getting taxed twice from the after-tax repayments in the loan interest, NOT the loan principal. The client of jkharvey will find no such research to support his opinion that loan payments can be made from pre-tax dollars!



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Posted 30 June 2004 - 04:22 PM

Prior "spirited" discussion.
...but then again, What Do I Know?

#6 MGB


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Posted 30 June 2004 - 05:05 PM

If this were the case, I'd be borrowing/repaying/borrowing/ infinitum because the tax preference keep doubling up each time. If I am in the 28% tax bracket, I make 28% on every borrow/repay.

My time to retirement affordability just got cut back from years to months.

Preposterous nonsense.

#7 Earl


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Posted 01 July 2004 - 10:38 AM

and I was going to take a loan to buy my groceries. drat!


#8 MGB


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Posted 01 July 2004 - 10:52 AM

Here is a simple example:

My annual compensation is 50,000. I borrow 50,000 from the plan (a nontaxable event). I now pay back the 50,000 out of my compensation. Under their theory, I have reduced my taxable income to zero. Note that nothing has changed in the plan (it is back to whole with no loan outstanding), and I now have 50,000 cash in hand instead of my after-tax amount of the 50,000 compensation. I've transformed my entire income into nontaxable income and owe no tax.

Quite preposterous.

#9 GBurns


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Posted 01 July 2004 - 04:48 PM

I am just playing devil's advocate just to get some feedback.

This employee has elected to defer $200 per month. The employee has a balance of $50,000 from which he/she borrows $10,000 (or whatever amount).

What stops this employee from "directing" the salary reduction of $200 towards loan repayment?

If this employee is allowed to "direct" the application of the salary reduction to loan repayment, it is in reality repayment with pre-tax $.

The questions are, Can the employee "direct" the salary reduction? Is this prohibited by the Plan Document? If the PD is silent, What stops the employee from doing this?

Other than being able to "direct" the application of the salary reduction, Could this employee transfer amounts within the overall account, anyhow? If internal transfers can be made, the employee could accomplish the same repayment with pre-tax $ by such a transfer.

How would the record keeper even know what was being done?
George D. Burns
Cost Reduction Strategies
Burns and Associates, Inc construction) construction)

#10 Earl


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Posted 01 July 2004 - 05:21 PM

I would think the employee can "direct" the deposit of his deferral. To the available investment options. Loan repayment is not an investment option.

A recordkeeper could be given incorrect information and he would never know. Until the census report reflects a deferral (pre-tax) and all the record keeper saw was loan repayments (after-tax).


#11 pax


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Posted 01 July 2004 - 05:28 PM

... and the existence of the loan will probably also create another deduction from the employee's paycheck to repay the loan. That deduction is after-tax. There is no possibility of "directing" the deferral to pay the loan.

I like MGB's summary: preposterous.

#12 Nautical


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Posted 02 July 2004 - 10:07 AM

I want to work for that company :)