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Are Loans Taxed Twice??


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11 hours ago, mbrogers said:

Nope! it’s very simple but for some reason this whole thread is dedicated to making something so easy to understand so complex lol. What everyone is failing to understand and realize is that you aren’t simply getting $10,000 tax free!!!! It’s a loan! You are paying this loan BACK! And you are paying this loan back with TAXED INCOME! So if you borrow $10K pretaxed dollars and then pay it back whether over 1 week or 3 years with TAXED INCOME then you have paid taxes on that $10K loan. And at retirement, when you go to withdraw that same $10K you paid back with TAXED INCOME, you will pay taxes again! Therefore you pay taxes twice! It’s maddening how people don’t get this. 

Let me give you an example that proves you wrong (and it's because money is "fungible.")

Day 1, you borrow $10,000, and you spend it.  You pay no tax on this money - because it is a loan.

Day 2, you repay the loan with $10,000 you had in a savings account, plus $0.01 interest.

Your "tax situation" is EXACTLY the same if you take the loan and spend it, repaying with other money you had, or if you DON'T TAKE THE LOAN, and use the $10,000 in savings for your purchase.  Your "tax consequences" do NOT CHANGE because you take the loan, and the TOTAL TAX you pay is exactly the same either way.

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I think this sums it up well. I like the missing dollar puzzle the person throws in, but also the fact if I borrow the 10,000 from the bank I am not taxed twice. since I was never taxed on the amount from the 401k it is the same thing.

Now if you want to argue the world is flat, well.....



401k Loan Double Taxation Myth

I don’t know who started it. Suze Orman certainly helped spread it. She says that you shouldn’t borrow from your 401k (or 403b) plan because you will be double-taxed. I did a Google search and I found 5 priceless money-saving tips by Suze Orman:

“Also, never ever borrow against your 401k plan because you will pay double taxation on the money you borrow. Because you don’t pay taxes on the money you put into a 401k, when you pay back the loan (which you must do within five years, or 15 years if used to buy a home), you pay it back with money you have paid taxes on. Then, when you retire and take the money out again, you end up paying taxes on it a second time.”

This allegation is all over the place. It is a myth because there is NO double taxation. It’s a mind trick similar to that well-known “where’s the missing dollar” puzzle.

“Three men went into a hotel. The manager said the room was $30 so each man paid $10. A while later the manager realized the room was only $25 so he sent the bellboy to the 3 guys’ room with $5. The bellboy only gave each man $1 back and kept the other $2 for himself. Now 3 men paid $9 each for the room, which is $27. Add the $2 that the bellboy kept, and that’s $29. But the 3 men paid $30 originally. Where is the other dollar?”

I was able to find a good explanation for this puzzle. The $30 number is irrelevant. The correct math is $27 – $2 = $25. It makes no sense to add $2 to the $27 because it’s already a part of the $27. The $2 should be subtracted from the $27.

Now, back to our 401k double taxation myth. The fact that the loan has to be repaid with after-tax dollars is irrelevant, just like the $30 number in the hotel puzzle. If you didn’t borrow from the 401k plan but you borrowed from a bank, you’d have to pay the bank back with after-tax dollars as well. If you didn’t borrow from your 401k plan but you dipped into your own savings, you have to replace those savings with after-tax dollars too. What it really means is that a 401k loan is not tax deductible, just like any other consumer loan except a mortgage or a HELOC. Instead of saying you will be double taxed, they should just say that a 401k loan is not tax deductible, plain and simple.

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If anyone is interested in a mathematical analysis of this question, here is something I put together a while ago. Hopefully this puts the question to bed for anyone who is still unconvinced.


Free advice is worth what you paid for it. Do not rely on the information provided in this post for any purpose, including (but not limited to): tax planning, compliance with ERISA or the IRC, investing or other forms of fortune-telling, bird identification, relationship advice, or spiritual guidance.

Corey B. Zeller, MSEA, CPC, QPA, QKA
Preferred Pension Planning Corp.

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Here is an example I used when I taught a "lunch and learn" to new hires on Loans many years ago.

You have a balance of $20,000 in your 401(k) plan, all deferrals.  No taxes yet.  You take a loan of $10,000 from your deferral account that you did not pay taxes on yet.

You get a check for $10,000 and you take it to the bank and cash it.  You get all $1 bills because you always wanted to see what 10,000 bills look like.

Then you bring it all home, spread it on the bed, get naked and roll around in it. (My supervisor asked me to take out the 'naked' part for subsequent discussions).

So far, no taxes.

You do this every day for a month.  Then you scoop up all that cash, pile it up nicely and return it to the bank.  (STILL no taxes).

The next day, you write a check to the custodian for $10,100 for principal and interest.  Now, so far, only $100 of that money has been taxed.

A week later, you quit and decide you need the money for a "personal growth" trip through Europe.  You weren't the best investor, nor the worst, and your account had zero dollars in gains or losses.  You get a distribution of $20,100.  You are taxed on the totality of that amount.  And only $100 of it was taxed before.


Two wrongs don't make a right, but three rights make a left.

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19 hours ago, mbrogers said:

I didn’t say there is any increase in tax but that you pay taxes twice. And I’ve made that extremely clear. Whatever you put in a 401K isn’t taxed and lowers your taxable income. Your 401K monthly loan payments aren’t paid with pre tax money therefore the money used to make those payments is taxed because it’s  treated as income. So if the 401K loan payments are paid with after tax money then at retirement it’s taxed a second time. If the loan payments came out pretax as contributions do then 1) your taxable income would remain the same and 2) you would only pay tax when you retired (once) 

$10,000 monthly salary 

 - $200  401K loan payment pretax 

= $9800 (taxable income)

- $2940 / 30 percent tax 

= $6860



$10,000 monthly salary (taxable income) 

- $3000 / 30 percent tax 

= $7000 

- $200 401K loan payment 

= $6800


The proceeds of the LOAN are irrelevant as it’s a loan not a withdrawal thus you should NOT be paying a loan back with taxed money yet are with a 401K loan. 

I wish we could waive a magic wand and make you see the mathematical error you are making. I wish you could just trust us that you ARE making an error.  But that probably won't happen.

This reminds me of the Monty Hall problem; there are still people who argue that you are NOT better off by switching doors (that it is just a 50/50 chance when really your odds are increasing to a 67% chance of winning).  https://en.wikipedia.org/wiki/Monty_Hall_problem

So, maybe (just maybe) this will work.  Let's have a loan with a 0% interest (if that was legal).  Now, borrow $10,000.  Now, pay it back at the rate of $100/week.  When you took out the $10k, you didn't pay tax on it (because it isn't a distribution, it's a loan just like you would get from the bank: the plan IS the bank!).  Now, when you pay it back, you are just giving the plan back the $10k you borrowed.  Assume you stuck it in your mattress because you ended up not needing it (the $10k "need" feel through).  After you have paid back the loan with the money you took out as a loan, how are you in any different tax situation than if you hadn't borrowed anything?

Is that any help? Probably not I guess.  Monty Hall! :-)

Lawrence C. Starr, FLMI, CLU, CEBS, CPC, ChFC, EA, ATA, QPFC
Qualified Plan Consultants, Inc.
46 Daggett Drive
West Springfield, MA 01089

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Let me try.

Scenario 1 - You want to buy a $10,000 widget.  You earn $13,000 in wages, pay $3,000 in taxes, and with the remaining $10,000, you buy the widget.  Net result - $3,000 paid in taxes and 1 widget owned.

Scenario 2 - You want to buy a $10,000 widget.  You borrow $10,000 from your 401(k) and put it in the bank.  You earn $13,000 in wages, pay $3,000 in taxes, and with the remaining $10,000, you buy the widget.  You then repay the $10,000 to the 401(k) from the bank.  Net result - $3,000 paid in taxes and 1 widget owned. 

Scenario 3 - You want to buy a $10,000 widget.  You borrow $10,000 from your 401(k) and buy the widget.  You earn $13,000 in wages, pay $3,000 in taxes, and with the remaining $10,000, you repay the 401(k) loan.  Net result - $3,000 paid in taxes and 1 widget owned. 

You don't attribute the taxes to the loan repayment, but to the wages earned.

 - There are two types of people in the world: those who can extrapolate from incomplete data sets...

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11 minutes ago, XTitan said:

… a $10,000 widget.  

I have some widgets for sale. Price negotiable.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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the last time I bought a widget from you also charged me for taxes. the widget was broken and I returned it and you refunded everything but the taxes I paid claiming it was non-refundable. so I ordered a replacement and you charged me taxes again, thus I really did end up with being taxed twice. I'm leaving you 'alone' before I would order again from you.

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Aren't you the one who claimed that when you ordered some batteries that they weren't included, so you had to order them again?

 - There are two types of people in the world: those who can extrapolate from incomplete data sets...

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