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 do a 401k plan loan is that you will pay income tax twice on the amount. First the loan repayments are made with after-tax income (that's once) and, second, when you take those payments out as a distribution at retirement you pay income tax on them (that's twice). So yes, you pay twice. But this is the wrong question.
What you should ask is, "Do I pay more income tax with a 401k loan than if I borrowed the dollars using some other type of loan?"
The answer is no, you do not pay any more taxes with 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 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 your 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.
Learn more about plan loans here: 401k Retirement Plan Loans: An Overview.
This is for educational purposes only. The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.
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