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vinnie C
Mar 9, 2013, 08:57 AM
I took a primary home loan disbursement from my 401k and pay it back principle and interest in after tax money. Shouldn't the interest be considered as after tax contributions and part of a cost basis for the 401k? This is not my first loan and I want to know if it would apply to past loans as well.

ScottGem
Mar 9, 2013, 09:59 AM
Interest paid on a 401(k) loan is considered investment income to the 401(k). It should be treated no different than any other earnings on assets held by the 401(k).

ebaines
Mar 11, 2013, 05:52 AM
ScottG is correct - but to be sure your question is answered: the reimbursement from your wages to repay the loan is after-tax money, not pre-tax. To help understand why remember that your contributions to a 401(k) are tax-deferred, not tax-free. If you contribute, say, $1000 to your 401(k) using pre-tax dollars sooner or later Uncle Sam is goint to collect income tax on that $1000, the only question is when - whether in retirement, or as an early withdrawal, or by your beneficiary if you die first. Taking a loan doesn't change the fact that someone, some time, has to pay income tax on that $1000. Now suppose that you were able to take a loan worth $1000 and then could repay it all with pretax dollars - this would put the account back to a value of $1000 but you would have defferred income tax on $2000 worth of contributions. Ultimately Uncle Sam would be "out" of income tax on $1000 worth of income. So you see it wouldn't work out.

ScottGem
Mar 11, 2013, 08:20 AM
I missed that part of your question. ebaines is correct the full loan payment (prinicpal and interest) is made with After tax dollars.

Essentially, when you take out a loan against your 401(k) you are making an investment, just like a bank does when you take a out a loan. The bank expects a return on its investment that is represented by the interest on the loan. So the principal portion of the loan payment goes to replace the principal borrowed. So the principal portion is just replacing cost basis. The interest becomes investment income. So you are essentially paying yourself interest.

This is why a 401(k) loan is such a good deal. Essentially, the loan is free since the interest you are paying is going right back into your account.