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For instance, though you probably know the initial borrowing
has no federal income tax effect, you might be wondering whether the interest
you pay will be deductible. In general, the answer is no. That's true even when
you use 401(k) loan proceeds for your home.
Ordinary loan repayments are not taxable events either. That
is, you don't have to pick up the interest you repay into your account as
taxable income. And, though you're increasing your 401(k) account with the
principal portion of each payment, that amount is not considered a
contribution. You can still make pre-tax contributions up to the annual limit
($17,500 for a traditional 401(k) during 2013, plus an additional $5,500 when
you're age 50 or older).
What if you default on the 401(k) loan? The balance of your
loan is considered a distribution to you, and you'll have to report it as
ordinary income on your federal tax return. In addition, when you're under age
59½, a 10% early-withdrawal penalty typically applies.
Being both a 401(k) borrower and a lender can lead to tax
surprises. Give us a call to make sure you have the whole story before you
arrange a 401(k) loan.
Last Updated by Tax on 2013-09-18 12:26:43 PM