FAQ - ANSWER

Do you pay income tax twice when you take out a 401k plan loan?

Answer: It is often claimed that one of the reasons that you should not take out a 401k plan loan is that you will pay income tax twice on the amount: first the loan payments are made with after-tax income (that's once) and, second, when you take you take those payments out as a distribution at retirement (that's twice). This is incorrect, you do not pay any more taxes on a 401k loan than you would on any other type of loan. Think about it. You will be paying off the non-401k loan with after-tax income (that's once) and your contributions and earnings in your 401k (you will have the dollars invested in something since you have not borrowed them) will be tax at distribution (that's twice). The taxation is exactly the same whether you borrow from you 401k or from another source.

The real cost is a possible opportunity loss, i.e., you may be able to earn more investing the dollars than you will from the loan interest over the life of the loan. Plus, there is the danger that if you lose or leave your job, the remaining loan balance is going to become taxable income unless you can pay it off.

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