Sounds like she’s trying to invest with leverage. She probably thinks that way she’ll have both the max deferral in the 401(k) invested and the Roth IRA invested.
In reality the 401(k) funds are liquidated and paid out to you, then you pay yourself back + interest.
A potential benefit is that you’re actually adding more than the deferral limit to the 401(k) because you’re adding that extra interest to it over the course of the loan term.
However, there’s typically a loan distribution fee that would negate part, if not all, of the benefits of this strategy.
You’d also be inadvertently market timing. Let’s say you request the loan, the funds are liquidated, and during the few days it takes for the funds to arrive so you can reinvest it in the Roth IRA the market jumps up 5%.
You miss out on those returns entirely.
So… Could it work? Sure… But at best you’re dollar cost averaging a tiny amount more than the deferral limit into the 401(k).
At worst you’re paying a fee for the privilege of missing out on market returns and adding unnecessary complexity to your investment strategy…
If you’re able to both reach the max and pay off the loan every year then you’re able to reach the max and fund the Roth IRA directly every year… The loan in the middle doesn’t make sense.
A couple minor corrections to other comments:
401(k) loans are not penalized for early withdrawal
You do have to pay back the loan + interest, but that interest goes to your 401(k) account, not the lender, so it’s not the same as paying interest on a bank loan.
If you lost your job you’d have some time (though not a lot) to repay the loan before it’d be treated as an early withdrawal.
Some plans (very rare) also allow you to continue making payments after termination.
