When 401K Loans Go Bad

When paying big bills such as a down payment on a house or a child’s tuition, many people will take out a 401K loan where they work. Generally, this is an excellent decision: the payroll department will have you pay the loan back via payroll deduction. You’ll essentially be paying yourself with interest to boot!

But what happens if you borrowed money from your company’s 401K plan and then leave your job? Most plans had required payback of the loan in full within 60 days of your termination (recent tax reform has somewhat extended the time to rollover the unpaid loan balance). If you don’t have the money to pay, your old employer will convert the loan into a taxable distribution. With a distribution, you’ll not only owe the taxes on the distribution, but very possibly may additionally owe a 10% penalty if you are under 59 ½ years of age. (If one separated from service in the year they turned 55 or older, there would be an exception to this penalty).

This loan that was lovely and helped you through a pressing financial need, has now morphed into a deadly distribution that will slam you with all sorts of unnecessary taxes and penalties. It pains me to see so many people plagued with this sort of problem when they can least afford it because they failed to plan in advance.

Give us a call at 516-294-5297 if you are currently facing or foresee yourself facing this sort of scenario in the future.

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