401K loan/double taxation

Submitted by mike youngblood on Tue, 2009-08-18 16:19

I recently retired from GM. I noticed that my pretax and post-tax records didn’t reflect my stock savings repayments. I had taken stock savings loans of about $125K and my total account approximately of $200K. I discussed with GM and they said as long as Fidelity properly recorded my pretax and post-tax funds, I would be ok. Fidelity said all loan repayments of pretax money must be recorded as pretax. All my stock savings repayments have been taxed, but are shown by Fidelity as pretax money.

So I have paid taxes on money earned, sent it post tax to Fedelity as SSPP loan repayments and now have no tracking of these post tax $ vs pretax $ within my 401K. Is there a method of correcting this or is my life savings essentialy taxed at 70% by double taxation? No where in the Fidelity reasons to consider not taking stock savings loans is there any mention of the double taxation of funds. I suspect this is a systemic major issue for many 401K owners and have never seen it addressed, even in your books.

Both GM and Fedelity say the other party is the remedy. Neither will help me.
Tamara Sullivan Miller is my CPA in Lapeer, MI. My understanding is that she is Slott trained. What can I do to resolve this mess and can you please warn people about this situation? I expect there is a huge number of people affected in 401Ks by this and problem and Fidelity seems unconcerrned. Don’t they have the obligation to correctly track the pretax and post tax basis of my money? Thank You
Mike Youngblood



Submitted by mk foss on Tue, 2009-08-18 17:43

If I’m following you, you borrowed money from the 401k plan and then paid it back. The custodian treats the loan to you an another investment and when it is repaid, it is reinvested again. The question is whether you get basis for repaying the loan.

When you buy assets outside a retirement account, your basis does not change if you have a loan or if you do not. In general there is no basis created by a loan repyament.

There is one instance where you might have a loan in connection with your retirement plan. If you took an employee loan and defaulted, it would become taxable to you. If you paid it back (as required) after you paid tax on it, you would have basis.



Submitted by Alan Spross on Tue, 2009-08-18 21:05

Mike,
I agree with the prior response. This is assuming that EXCLUSIVE to the loan payments you had not made after tax contributions to the 401k, which would have created a basis (post tax amount) in the plan and would have been reflected on your statements. If that were the case, the loans should not have eliminated that basis from the plan.

That leaves the loan repayments themselves that I think you believe should establish a post tax basis in the plan to avoid double taxation after the final distributions. While you do not get basis for these after tax loan repayments, that does NOT mean that you will eventually be double taxed. The reason for that is that you were able to expend the loan proceeds tax free, which puts you in the same position as if you had used your after tax savings instead of a plan loan and replaced the after tax savings from after tax earnings.

The only double taxation you will pay is on the interest you were charged for the loans since this was additional funding to the 401k plan that did not originate there. The interest was new after tax money and will be taxed again upon distribution, but the interest payments would only be a fraction of your loan principal of 125k.

Therefore, Fidelity is correct in their accounting. I will be the first to concede that there is no simple way to explain this and that is why the concept of double taxation of loan amounts continues to be widely believed, but is not the case.



Submitted by mk foss on Wed, 2009-08-19 04:05

I always agree with Alan but I must disagree with the interest payments creating basis in the retirement plan. If you pay loan interest on any other obligation, it doesn’t create basis and it wouldn’t if the loan is to your retirement plan.

If you had after-tax basis in the plan and borrowed it, the repayment would not create additional basis – you just have the basis that you always had.

An employee loan is just an investment for the retirement plan, the identity of the borrower does not cause unusual tax treatment for either the lender or the borrower.



Submitted by Alan Spross on Wed, 2009-08-19 05:06

Mary Kay,
I hopefully did not indicate that interest payments create any basis. Note that in the second paragraph I stated to Mike that I thought that HE believed basis should be created by loan payments, but that it is not. Or perhaps it came from my opinion that principal repayment was not really double taxed??

The only way to actually create basis in the plan is to make after tax contributions or have contributions re cast as after tax by plan corrective procedures.

http://thefinancebuff.com/2008/07/401k-loan-double-taxation-myth.html

It seems that there must be an easier explanation than the above link.
Perhaps this: You are in fact taxed twice, but one of those times is negated by the fact that you took loan money out of the plan that should have been taxable, but was not. That wipes out the tax affect of the loan repayment being made with after tax dollars. So the final net result is taxation ONE time. (2-1=1)

What do you think?



Submitted by mk foss on Wed, 2009-08-19 21:08

I like the explanation someone gave who responded to that article:

Put money in 401k – not taxed, borrow money from 401k – not taxed, pay back loan – not taxed, take money at retirement – taxed.

The variation would be if there is after tax money in the 401k:

Put after-tax money in 401k – taxed, borrow money from 401k – not taxed, pay back loan – not taxed, take money at retirement – not taxed.

The only double-tax situation I can think of goes like this:

Put money in 401k – not taxed, borrow money from 401k – not taxed, default on loan – taxed, pay back loan – not taxed, take money at retirment – taxed to the extent it exceeds amount of defaulted loan previously taxed.



Submitted by mike youngblood on Thu, 2009-08-20 19:33

Here is a recent comment on my issue:

“Put money in 401k – not taxed, borrow money from 401k – not taxed, pay back loan – not taxed, take money at retirement – taxed.”

The thing I can not get my comprehension on is that the above statement is missing the fact that IN FACT every penny of loan payments was fully taxed.
The actual process was “Put money in 401k not taxed, borrow money from 401k – , pay back loan – With fully taxed money, take money at retirement – taxed.” so- to me this is still is same money twice taxed, once when I repaid it as a loan with post tax money and the second time when I eventally withdraw from the 401K. Please remember the GM practice is all loan repayments are taken out of after tax money, if it was from pretax money I would both fully comprehend the above quoted statement and agree with it.

I’m still not getting this?

Thank you all for your comments and time!!

Mike Youngblood



Submitted by mk foss on Thu, 2009-08-20 20:48

The point is that there is no difference in borrowing from a retirement plan than borrowing to buy a car.

If you pay a $20,000 car and finance $16,000. When the loan is repaid the basis of the car is $20,000 not $36,000.

Pre-tax money that goes into a retirement plan is not taxed until withdrawn, earnings in a retirement plan are not taxed until withdrawn, an employer match is not taxed until withdrawn, a loan is not taxed unless defaulted. Borrowing untaxed money and paying it back with after tax money does not make either the loan or the repayment taxable.

The point is that your basis in the retirement plan is only your after-tax contributions and either the employer or custodian should have that figure.



Submitted by Martin Helmer on Fri, 2009-08-21 00:18

Mike:
Put $100 in 401k-not taxed, borrow $100 from 401k-not taxed, pay back $110, thereby replacing $100 of plan value that has never been taxed and adding $10 of interest that becomes double taxed. If you totally default on the loan you still owe tax on the $100 and on the accrued interest.

The original $100 contribution was tax DEFERRED. If the $100 is not taxed at distribution, then that’s tax exemption and not tax deferral. Compare the result to your co worker who never took any $100 loan.



Submitted by Bruce Steiner on Fri, 2009-08-21 04:14

It’s no different from if you borrowed from an unrelated lender, and the plan (instead of making a loan to you) kept the money invested in other assets (to keep it simple, let’s assume the money in the plan is invested in bonds that earn interest).

In either case, your account in the plan goes up by the amount of interest earned on its bonds, or by the amount of interest it earns on its loan to you.

In either case, the interest you pay, either to the plan or to an outside lender, is or is not deductible in accordance with the rules governing the deductibility of interest.

In either case, when you borrow money, the principal that you borrow is not taxable when you borrow it, and is not deductible when you repay it. The reason it’s not taxable when you borrow it is that it’s presumed that you’ll repay it at some point. If for some reason something happens whereby you won’t ever have to repay it (for example, if the lender forgives the loan), the amount forgiven may be taxable at that point.

Bruce Steiner, attorney
NYC
also admitted in NJ and FL



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