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The choice is between paying interest to your 401k loan where it will later be taxed, or paying it to some other lending institution where it is just gone.

You're leaving out the income that the loan principal would have earned had you left it in the 401(k).

Let's say we're dealing with a principal of $10,000 and a loan at 5%. If you leave the money in the 401(k) and take an outside loan, at the end of a year you have $10,500 in the 401(k) that's never been taxed and you've paid $500 of post-tax interest. If you finance through a 401(k) loan, at the end of a year you have spent the same $500 of post-tax money on interest. You have the same $10,500 in the 401(k), but $500 of it has already been taxed and will be taxed again on retirement. I don't see the advantage unless the interest rate spread makes it worthwhile.

Phil Marti
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