You have to somehow earn that trillion dollars and pay taxes on it, before you can put it into your 401k, and you get no special tax treatment for putting that "interest" money into the account. When you eventually withdraw that trillion dollars in the future you are also paying taxes on it.
EXACTLY. I'll refer back to the article I linked to. I think you're assuming that because you have to pay income tax on your wages to pay the interest on the loan, you're being taxed twice on the same money. The fact that you had to pay income tax on the funds you earned to pay the interest on the loan is because the interest on that type of loan is not tax deductible. It is unavoidable, and therefore irrelevant. If you didn't take out a loan from your 401k and instead put your pay in your Scrooge McDuck pile, was it not all subject to taxation? There was no way to pay zero tax on the income earned to pay the interest on the loan, so it shouldn't be viewed as subject to some sort of double-tax penalty. You were always going to pay tax on that trillion dollars of income. You were always going to pay tax on the 401k distribution. Nothing changed just because you took the loan out from the 401k instead of a bank.
Just because I like to argue, what if you paid the interest back with a refundible tax credit like the EITC? Then is the interest you paid double taxed? Similarly, aren't YOUR tax deferred contributions to a 401k essentially double-taxed even if you never take a loan because the government had to have an offsetting income source to fund the tax deferrments in retirement plans?
I don't follow.
Scenario 1
1. I take out $100 loan from my 401k this year @ BIG^BIG %.
2. I earn $1.67T (I set aside $0.67T of that to pay my 40% income taxes), leaving me with $1T
3. I pay back $1T 401k loan.
4. I, rather stupidly, liquidate my 401k because I am of retirement age. I get $1T, all of which is taxable income (I set aside 40% of this [$0.40T] for income taxes as well)
5. Now I claim my W2 income value of $1.67T plus the $1T 401k distribution for a total of $2.67T in taxable income. (40% = $1.07T for taxes).
Cash = $0 + $100 from 401k, + $1.67T earned income, (-$1T back into your 401k, +$1T distributed out of your 401k), -$1.07T for taxes = $0.6T cash all said and done
Or
Scenario 2
1. Do not take out loan.
2. I earn $1.67T (I set aside $0.67T of that to pay my 40% income taxes), leaving me with $1T in my scrooge mcduck pile.
5. Now I claim my W2 income value of $1.67T in taxable income. (40% = $0.67T for taxes).
Cash = $0, +$1.67T earned income, -$0.67T for taxes = $1T (in large pile I will swim in)
The difference between taking the 401k loan (scenario 1) and not taking it and just putting money into my scrooge mcduck pile (scenario 2) illustrates how you are double taxed on that. There is a trillion dollars that is double counted as earned income on my W2 AND as income from a 401k distribution. This is literally the exact same trillion dollars being counted twice on my tax forms. If I wait to take a distribution from my 401k in a later year that tax is just delayed. In reality you are dealing with much much larger loan amounts, and much much lower interest rates. You can change the tax rate, and the loan terms, but the math is the same, the quantity of money double taxed will just be much smaller but still real.
Just because I like to argue, what if you paid the interest back with a refundible tax credit like the EITC? Then is the interest you paid double taxed? Similarly, aren't YOUR tax deferred contributions to a 401k essentially double-taxed even if you never take a loan because the government had to have an offsetting income source to fund the tax deferrments in retirement plans?
Because of the fungibility of money it’s irrelevant, but yes it is. If you get the EITC, under normal circumstances the money doesn’t show up as income on your tax return, and can be considered “post-tax money”. If you use it to pay back the interest portion of a 401k loan, then when you take a distribution that money will be counted as income and taxed.
No my original contributions are not double-taxed. Double taxed means some portion is literally counted twice on your personal tax return (not necessarily in the same year).