Comments on: 401k Loan Double Taxation Myth http://thefinancebuff.com/401k-loan-double-taxation-myth.html like a friend telling you about money ... Fri, 10 Feb 2012 17:31:35 +0000 hourly 1 http://wordpress.org/?v=3.1.2 By: SMW http://thefinancebuff.com/401k-loan-double-taxation-myth.html#comment-7874 SMW Tue, 31 Jan 2012 22:11:35 +0000 http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html#comment-7874 @Steve: You can do this, but it might be counter-productive, or at least unproductive. This might be a good idea in a bear market, and you have no better use for that money, but since it is a year after you could have been contributing, the opportunity cost is a little high, IMHO. You could have been contributing regularly to the IRA all during the past year, using the concepts of dollar cost averaging (DCA) and compounding. These concepts don’t always work in our favor, however, with 2011 as a good example: when a market ends the year at roughly the same point it began, with values increasing during the year then reverting back to the mean, you can actually lose money on a DCA basis. I find it hard to time markets with loans, and the risk, mentioned below, is a little uncomfortable for me. I think there might be better places to invest, but at only $5K, that risk is relatively low. You also bear the risk of leaving the job of the 401(k) sponsor, and not being able to pay back the loan immediately, triggering both the 72(t) early distribution (10%) penalty and income taxes on the amount not repaid to the 401(k). If your plan charges fees for loans, that may be a detractor as well: remember, once you start doing this, you might keep investing like this on an annual basis. If it’s a one-time deal, it’s probably relatively harmless. If it becomes a long term pattern, you could be eroding your investment basis through fees, and paying yourself a minimal return in many bull markets over your career. I'd say instead, start investing habitually. @Steve: You can do this, but it might be counter-productive, or at least unproductive. This might be a good idea in a bear market, and you have no better use for that money, but since it is a year after you could have been contributing, the opportunity cost is a little high, IMHO. You could have been contributing regularly to the IRA all during the past year, using the concepts of dollar cost averaging (DCA) and compounding. These concepts don’t always work in our favor, however, with 2011 as a good example: when a market ends the year at roughly the same point it began, with values increasing during the year then reverting back to the mean, you can actually lose money on a DCA basis. I find it hard to time markets with loans, and the risk, mentioned below, is a little uncomfortable for me. I think there might be better places to invest, but at only $5K, that risk is relatively low.
You also bear the risk of leaving the job of the 401(k) sponsor, and not being able to pay back the loan immediately, triggering both the 72(t) early distribution (10%) penalty and income taxes on the amount not repaid to the 401(k). If your plan charges fees for loans, that may be a detractor as well: remember, once you start doing this, you might keep investing like this on an annual basis. If it’s a one-time deal, it’s probably relatively harmless. If it becomes a long term pattern, you could be eroding your investment basis through fees, and paying yourself a minimal return in many bull markets over your career.
I’d say instead, start investing habitually.

]]> By: Steve http://thefinancebuff.com/401k-loan-double-taxation-myth.html#comment-7872 Steve Tue, 31 Jan 2012 21:48:13 +0000 http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html#comment-7872 Question Lets say someone contributes 5k yearly to their 401k. December rolls around and they want to add 5K to their IRa. Being that the 5k in the 401k is pretax, if they take a loan out for 5k can they now deduct 10k from their taxes? It would be a win win.. they are really only placing 5k yearly into their retirement acct, yet they are deducting 10k for tax reporting purposes. Also they are giving themselves guaranteed return on their 401k. Thoughts on this.. im sure there is no way this would work but curious to see what others think. Question

Lets say someone contributes 5k yearly to their 401k. December rolls around and they want to add 5K to their IRa. Being that the 5k in the 401k is pretax, if they take a loan out for 5k can they now deduct 10k from their taxes? It would be a win win.. they are really only placing 5k yearly into their retirement acct, yet they are deducting 10k for tax reporting purposes. Also they are giving themselves guaranteed return on their 401k.

Thoughts on this.. im sure there is no way this would work but curious to see what others think.

]]> By: Dean in NY http://thefinancebuff.com/401k-loan-double-taxation-myth.html#comment-7473 Dean in NY Thu, 08 Dec 2011 22:54:33 +0000 http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html#comment-7473 You are misleading people with this article. Yes you are not getting double taxed when comparing it to a credit card or non-tax deductible loan. But 401k loans in general are NOT tax deductible. So those of you borrowing from it to invest in something else (IRA) are losing doubly because they cannot deduct the interest they are paying. Even credit card interest is deductible when used for business or investment purposes. 401k interest is not deductible under these conditions. If you do not believe me, try to do this. It will take about 3-5 years for the IRS to catch it and catch up to you, and when they do.. look out! You are misleading people with this article. Yes you are not getting double taxed when comparing it to a credit card or non-tax deductible loan. But 401k loans in general are NOT tax deductible. So those of you borrowing from it to invest in something else (IRA) are losing doubly because they cannot deduct the interest they are paying. Even credit card interest is deductible when used for business or investment purposes. 401k interest is not deductible under these conditions. If you do not believe me, try to do this. It will take about 3-5 years for the IRS to catch it and catch up to you, and when they do.. look out!

]]> By: John Monahan http://thefinancebuff.com/401k-loan-double-taxation-myth.html#comment-7443 John Monahan Wed, 30 Nov 2011 21:11:38 +0000 http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html#comment-7443 @ SMW - In some cases, there should be a 99/1 rule - I worked under one of those... I have many reasons to dislike the Roth. As I said earlier, I would only use it as a position of last resort. I believe in filling up the bucket no matter what bucket the client prefers. I may take my best shot at educating them, but quite frankly (and I've run into this several times) they want a Roth no matter what, usually because their 'investment guru' (translation - the guy in the office or a friend talks like he knows what he's doing financially...) told them the Roth is the best thing since chewing tobacco. Sigh - ok - at least they're saving/filling the bucket. My main concern with the Roth (and frankly in today's political climate a lot of other things) is the ability for the govt. to change directions at any point they see fit. You only need point to a social program, started in the 1930's with no taxation on benefits, that 40 years later began taxing those same benefits. You know the one I'm referring to - SSI. So is it far fetched to think the Roth proceeds could be taxed? Maybe. Is it possible? You betcha. Lastly - your encapsulation of the miniscuilty (is that a word?) of the tax consequenses should be in a text book somewhere. Excellent summarization. I have accessed funds from 403(B) accounts for my wife and I and we've saved thousands and maybe tens of thousands of dollars in interest payments. May have cost me a couple of hundred in taxes, but I'll do that all day every day. Thanks for the concise description. @ SMW – In some cases, there should be a 99/1 rule – I worked under one of those…

I have many reasons to dislike the Roth. As I said earlier, I would only use it as a position of last resort. I believe in filling up the bucket no matter what bucket the client prefers. I may take my best shot at educating them, but quite frankly (and I’ve run into this several times) they want a Roth no matter what, usually because their ‘investment guru’ (translation – the guy in the office or a friend talks like he knows what he’s doing financially…) told them the Roth is the best thing since chewing tobacco. Sigh – ok – at least they’re saving/filling the bucket.

My main concern with the Roth (and frankly in today’s political climate a lot of other things) is the ability for the govt. to change directions at any point they see fit. You only need point to a social program, started in the 1930′s with no taxation on benefits, that 40 years later began taxing those same benefits. You know the one I’m referring to – SSI. So is it far fetched to think the Roth proceeds could be taxed? Maybe. Is it possible? You betcha.

Lastly – your encapsulation of the miniscuilty (is that a word?) of the tax consequenses should be in a text book somewhere. Excellent summarization. I have accessed funds from 403(B) accounts for my wife and I and we’ve saved thousands and maybe tens of thousands of dollars in interest payments. May have cost me a couple of hundred in taxes, but I’ll do that all day every day. Thanks for the concise description.

]]> By: SMW http://thefinancebuff.com/401k-loan-double-taxation-myth.html#comment-7442 SMW Wed, 30 Nov 2011 20:14:07 +0000 http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html#comment-7442 @John Monahan - I agree on your point concerning Roth IRAs, especially when anyone proclaims: "everyone should have one" or "the only account you need is..." And to the other comments: maybe we should apply the 80/20 rule to financial planning talking heads - take 80 percent at face value, and view the rest with raised eyebrow. @dd - If I'm understanding your complaint correctly, you wish that it would be allowed for your interest paid to be allocated to the pre-tax portion of your retirement account. I think you're spot on. TFB, I get your point that the interest is replacing what would otherwise be earned in the markets (at least that was Congress' intent when they allowed plan loans), but its future value, and potential, is the same as contributions, so even those of us in the plan administration field do view it as similar to another type of contributions - earnings. They are contributed by the markets. The account balance and it's taxable value are the concerns. This is one of those social policy issues, where Congress' other intent was to mildly discourage borrowing from retirement plans: to tax those post-tax, out-of-pocket loan interest payments. But again, the effect of that tax is so minor, really percents of percents, that, as we've agreed in this "forum" in the past, should not be a deterrent to borrowing against your retirement plan funds if you have greater investment/savings opportunities elsewhere (doesn't stop me, and I've designed plans!). @TFB - while I don't agree with you on everything, I think your website and the discussions it engenders are great. You attract people online who really are interested in becoming financially educated. @John Monahan – I agree on your point concerning Roth IRAs, especially when anyone proclaims: “everyone should have one” or “the only account you need is…” And to the other comments: maybe we should apply the 80/20 rule to financial planning talking heads – take 80 percent at face value, and view the rest with raised eyebrow.
@dd – If I’m understanding your complaint correctly, you wish that it would be allowed for your interest paid to be allocated to the pre-tax portion of your retirement account. I think you’re spot on. TFB, I get your point that the interest is replacing what would otherwise be earned in the markets (at least that was Congress’ intent when they allowed plan loans), but its future value, and potential, is the same as contributions, so even those of us in the plan administration field do view it as similar to another type of contributions – earnings. They are contributed by the markets. The account balance and it’s taxable value are the concerns. This is one of those social policy issues, where Congress’ other intent was to mildly discourage borrowing from retirement plans: to tax those post-tax, out-of-pocket loan interest payments. But again, the effect of that tax is so minor, really percents of percents, that, as we’ve agreed in this “forum” in the past, should not be a deterrent to borrowing against your retirement plan funds if you have greater investment/savings opportunities elsewhere (doesn’t stop me, and I’ve designed plans!). @TFB – while I don’t agree with you on everything, I think your website and the discussions it engenders are great. You attract people online who really are interested in becoming financially educated.

]]> By: dd http://thefinancebuff.com/401k-loan-double-taxation-myth.html#comment-7440 dd Wed, 30 Nov 2011 19:02:13 +0000 http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html#comment-7440 Ok, I am convinced now, the last example was good. Ok, I am convinced now, the last example was good.

]]> By: TFB http://thefinancebuff.com/401k-loan-double-taxation-myth.html#comment-7435 TFB Wed, 30 Nov 2011 16:23:30 +0000 http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html#comment-7435 @Josh B, @dd - Loan interest and contributions are different concepts. Loan interest comes from time value of money. If you are replacing $100 pretax money a year from now, you have to replace it with $105 because of time value of money. The extra $5 isn't a contribution. Suppose both you and your co-worker are borrowing the same amount on the same terms but you are borrowing from her account and she's borrowing from yours. The cash flows from your pockets and to your accounts are identical with a regular 401k loan. Your accounts don't care where the money comes from and you don't really care to whose account you are repaying. You got a loan. You are paying interest. That's all. You are not making a non-standard contribution to her account. You are paying interest to compensate her for the time value of money. Of course she should be taxed for that. It's the same when you and she are the same person. The public wants a simple, black-and-white solution for their money questions. Suze Orman fills that need. A consultant to financial planners <a href="http://www.kitces.com/blog/archives/118-Do-Financial-Planners-Have-Something-To-Learn-From-Suze-Orman-and-Dave-Ramsey.html" rel="nofollow">lamented</a> that all the CFPs in the country added together don’t have as much reach as three mass marketing gurus: Suze Orman, David Bach, and Dave Ramsey. It's the same as McDonald's. It's fast, cheap, and it serves far more customers than white-table-cloth restaurants. If you are hungry, McD's will do. Just don't eat there every day. @Josh B, @dd – Loan interest and contributions are different concepts. Loan interest comes from time value of money. If you are replacing $100 pretax money a year from now, you have to replace it with $105 because of time value of money. The extra $5 isn’t a contribution.

Suppose both you and your co-worker are borrowing the same amount on the same terms but you are borrowing from her account and she’s borrowing from yours. The cash flows from your pockets and to your accounts are identical with a regular 401k loan. Your accounts don’t care where the money comes from and you don’t really care to whose account you are repaying. You got a loan. You are paying interest. That’s all. You are not making a non-standard contribution to her account. You are paying interest to compensate her for the time value of money. Of course she should be taxed for that. It’s the same when you and she are the same person.

The public wants a simple, black-and-white solution for their money questions. Suze Orman fills that need. A consultant to financial planners lamented that all the CFPs in the country added together don’t have as much reach as three mass marketing gurus: Suze Orman, David Bach, and Dave Ramsey. It’s the same as McDonald’s. It’s fast, cheap, and it serves far more customers than white-table-cloth restaurants. If you are hungry, McD’s will do. Just don’t eat there every day.

]]> By: John Monahan http://thefinancebuff.com/401k-loan-double-taxation-myth.html#comment-7427 John Monahan Wed, 30 Nov 2011 13:26:50 +0000 http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html#comment-7427 dd's point stated extremely well, and I have to agree. While both Suzy O. AND Dave Ramsey have brought some semblance of basic understanding to the masses, one has to recognize that their aim is exactly that - ease of understanding to the masses. One example of this point: both laud the benefits of using the Roth IRA. Having been in financial services myself, I have a basic disagreement about the Roth products, but for the general public - especially those who are currently not saving at all - the Roth is a an easily understandable way to save money with expected tax saving benefits. Is the traditional IRA, 401(k) or 403(b) a better choice? In my estimation, yes, but probably a discussion for another forum. However educating a less-than-sophisticated group of new savers (particularly en masse and by popular media) can be a long process which can and does eat up precious saving time. Here the time honored, "Time is money" is precise and to the point. Get 'em saving is paramount. dd’s point stated extremely well, and I have to agree. While both Suzy O. AND Dave Ramsey have brought some semblance of basic understanding to the masses, one has to recognize that their aim is exactly that – ease of understanding to the masses.

One example of this point: both laud the benefits of using the Roth IRA. Having been in financial services myself, I have a basic disagreement about the Roth products, but for the general public – especially those who are currently not saving at all – the Roth is a an easily understandable way to save money with expected tax saving benefits. Is the traditional IRA, 401(k) or 403(b) a better choice? In my estimation, yes, but probably a discussion for another forum. However educating a less-than-sophisticated group of new savers (particularly en masse and by popular media) can be a long process which can and does eat up precious saving time. Here the time honored, “Time is money” is precise and to the point. Get ‘em saving is paramount.

]]> By: dd http://thefinancebuff.com/401k-loan-double-taxation-myth.html#comment-7425 dd Wed, 30 Nov 2011 12:50:30 +0000 http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html#comment-7425 Josh B, I agree with you that this area could have a number of interpretations: this is probably why there is so much confusion. Somehow the current interpretation does not seem intuitive, but does maximize government revenue. I am not a fan of Suzy Orman and prefer the Jane Bryant Quinn. Although Suzy Orman's recommendations are not always 100%, most of her recommendations follow generally accepted financial concepts. She has simplified and popularized financial literacy to the benefit of many. Josh B, I agree with you that this area could have a number of interpretations: this is probably why there is so much confusion. Somehow the current interpretation does not seem intuitive, but does maximize government revenue.

I am not a fan of Suzy Orman and prefer the Jane Bryant Quinn. Although Suzy Orman’s recommendations are not always 100%, most of her recommendations follow generally accepted financial concepts. She has simplified and popularized financial literacy to the benefit of many.

]]> By: Josh B http://thefinancebuff.com/401k-loan-double-taxation-myth.html#comment-7424 Josh B Wed, 30 Nov 2011 07:29:50 +0000 http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html#comment-7424 @TFB - Perfect simple explanation for the non-interest part. I don't see why there's so much confusion on this. Strictly speaking, i would say the interest is double taxed from the perspective of the 401k owner. You call the interest payments earnings of the 401k plan, but someone else could just as validly argue they are non-standard contributions. I think the interpretation is arbitrary in that the law could have been written either way. It's not a surprise that it's written to maximize government revenue. @TFB – Perfect simple explanation for the non-interest part. I don’t see why there’s so much confusion on this.

Strictly speaking, i would say the interest is double taxed from the perspective of the 401k owner. You call the interest payments earnings of the 401k plan, but someone else could just as validly argue they are non-standard contributions. I think the interpretation is arbitrary in that the law could have been written either way. It’s not a surprise that it’s written to maximize government revenue.

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