Thursday, April 17, 2008

Double Trouble

This is not a good sign as it relates to the economy nor does it bode well for the future retirement of these individuals.

What's even worse, one who borrows from a 401k, if intending to pay the loan back, exposes oneself to one of the few situations where an individual will be taxed twice on the same dollars.

As you may know, contributions to a 401k are tax deductible, grow tax deferred, and are taxed at distribution. When the owner of the 401k takes a loan, the loan comes out tax-free but is paid back with after-tax (already-taxed dollars). When those dollars are distributed back at retirement, they are taxed again.

If the loan remains at termination of employment, the loan almost always has to be paid back, or it will be considered a distribution. A distribution before age 59 1/2 will most likely result in a tax liability and a 10% penalty.

It is probably better to borrow the money elsewhere if at all possible and reserve the 401k loan option for only the most dire circumstances.

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