Ask Bob: Are 401(k) Loan Repayments Double Taxed?

Robert Powell, CFP®


My wife and I took out a 401(k) loan to assist us with the cost of renovating our newly acquired home. 

We've been repaying the loan back to the 401(k) but still have some ways to go. As you know, the loan repayments themselves are taxed and the eventual withdrawals get taxed as well, creating unfavorable double taxation.

Since we are already paying tax on the loan repayment, can we repay the loan back to a Roth IRA? This would allow us to avoid the withdrawal tax and the ability to grow our investments tax-free! We have searched online but could not find any information. Please help!


This is a topic that is commonly misunderstood and can easily result in misguided interpretations, says Dennis LaVoy, a certified financial planner with Telos Financial.

The short answer to your question is no, you cannot borrow from a traditional 401(k) and repay a Roth 401(k), says LaVoy. “That would be pretty cool if you could, but it’s just not allowed. Loan repayments go back where they came from in the manner they came out.”

Furthermore, when you borrow from a 401(k), most plans dictate how those funds are to be withdrawn. “For example, let’s say you have a 401(k) worth $100,000 and $50,000 of that is traditional or pretax and $50,000 of it is Roth,” says LaVoy. “Let’s assume you decide to take a loan from your 401(k) for $50,000. Your 401(k) plan document should provide guidance for how your withdrawal will come out.”

It may state, for instance, that loans come out from pretax first or come out prorated from each area of tax status as a couple of examples. “You normally don’t get to make this election,” says LaVoy.

Next, let’s clarify an erroneous statement you’ve made and discuss a bit.

There is not actually double taxation on the loan repayment. It’s easy to see how you arrive at that conclusion, but it’s just inaccurate.

According to LaVoy, money goes in after taxes and you have to pay taxes again when withdrawn.

“When you pay this back, it’s after-tax and when you withdraw in the future you have to pay tax again; but remember, the money you’re paying back, you’ve already received tax-free from deposits and growth that were all tax-free,” says LaVoy. “That withdrawal you spent is really the money you’re paying taxes on via your payback. It’s a lump sum you got tax free. The 401(k) loan simply gives you the ability to defer the tax bill to align with your repayment schedule over a number of years, making it a more beneficial strategy from a pure tax view.”

How about an illustration to help clarify.

Let’s say you borrow $50,000 from your traditional 401(k). The money went in tax-free and comes out tax-free. Now, let’s say you bury that money in a coffee can in your backyard. You still have saved the money without paying taxes on it and received the loan proceeds without paying taxes on it. Now after some time period, a month, a year, a week, doesn’t matter, you dig the can, still with $50,000, and pay the loan back. Money in, money out, money back in, never taxed. It would later be taxed in retirement when you take a withdrawal. So, no duplicated taxes here, right? You withdrew money tax-free and paid it back tax-free.

“To think this is double taxed is to forget that you received a distribution in the form of a loan that was never taxed,” says LaVoy. “If you view it on a consumption basis, that is to say, the funds are taxed when they’re spent, you’re paying the tax on this as you earn it over the next few years, again delaying the tax liability. If you didn’t have to pay back a 401(k) loan with after-tax dollars, you’d be avoiding tax on that loan altogether and it would be a major loophole to get tax free distributions from 401(k)s.

There’s a case to be made that the interest you repay is double taxed, says LaVoy. “But you could also argue you get a discount on it and the ability to add more to your 401(k) than limits allow. It depends on return and taxation assumptions which side you are on there,” he says.

This is where there’s some argument to be had, says Lavoy. “The money you pay back in interest could arguably be double taxed,” he says.

Let’s say you withdrew a $100 loan and paid it back over a number of years, so the total you paid back was $110. That $100 was money you spent (presumably when you took the loan) and paid taxes on the distribution since it was not previously taxed (via the payback to the account).

The $10 you paid in interest could be considered double taxed. As it is after-tax money that is put into the account that will again be taxed when withdrawn. It’s not a replacement of a distribution or a new dollar you consumed.

To argue if this is double taxed or not is really an academic argument, says LaVoy. “It’s essentially debating which is greater, the pretax rate of return used in the time value of money or the interest rate paid on the loan,” he says. “It can get messy quickly, but basically, is the interest paid greater than the value of the time you borrowed the funds.” 


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