Hi,
I have read several questions and answers from this forum about the tax treatment of 401k loan repayment. Overall, the opinion seems to be that the loan repayment is not taxed. But I am confused about this opinion. Because I am repaying the loan (principal + interest) using after-tax money, it is being taxed, right?
Just to make things concrete: let's say my 401k loan amount is 9000 and interest is 1000, and I am paying it in 1 year, so essentially I am paying 10000 in 1 year (833.33 per month). I see that the plan administrator is deducting 833.33 from my bank account (after-tax money). So in a sense, I am paying tax on 10000, right?
Can someone explain please? Thanks in advance.
You do not need to report anything regarding a 401(k) loan repayment in your tax return.
Indeed, you are repaying the loan with after-tax money. However, the loan distribution was also given to you tax-free. The impact to your taxable income occurred when you originally contributed to the 401(k), and will occur again when you draw on this at retirement (or take early withdrawals that are not loans).
Regarding the interest, yes, you are paying the interest with after-tax money, with no offsetting deduction available. So you'll be double-taxed when you receive this back as income in retirement. However, since you are paying the interest to yourself instead of a bank, most people find this result tolerable.
Here's some more information on 401(k) loans: 401(k) loan