401k loan default after leaving a job

[dallen4]

I'm about to leave my job and I have an outstanding 401k loan on the plan.  I have a total of about 98000 in my 401k with a 38000 loan right now.

From what I understand, when I leave my job, I can call my 401k provider, tell them I want to treat the 38000 as a withdraw. They will then take out 38000 from my 98000 balance so that leaves me with 60,000 in my 401k that I can then roll over, withdraw, or keep it where it is.

My question is rather simple, can I then use the 60,000 balance and use it to pay the federal/state taxes I would owe? So if I said I wanted to withdraw 50,000, I have to treat it as if I took out 88,000 and hold the taxes for the federal/state and all that. What I gather they would hold 10% penalty and a 20% federal hold so that leaves me with $35,000. I can then use that to pay off the taxes I'd owe for both the 50k withdraw and the 38k withdraw. Is that true?

Is that an option to do? Am I missing something here? I don't want to mess this up for obvious reasons so I'm trying to get a clear understanding of what my options are. What I understand they let you borrow up to 50% of your balance for this very reason... in case you can't repay the loan then you can use the remaining balance to cover the taxes and fees.

[JoannaB2]

It depends.  You may withdraw form your 401k to pay off taxes subject to federal and state income taxes.  If you leave your job (whether voluntarily or involuntarily) with an unpaid loan balance, your former employer may allow you a period of time to pay off the loan. But if you can’t, the plan will reduce your vested account balance in order to recoup the unpaid amount and is called a “loan offset.”. The offset amount is considered a distribution subject to tax and the 10% early distribution penalty if you’re under age 59 ½. However, if you come up with the funds, you can avoid immediate tax and penalty by rolling over the offset amount to an IRA or another company plan.

[dmertz]

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@dallen4 wrote:

My question is rather simple, can I then use the 60,000 balance and use it to pay the federal/state taxes I would owe? So if I said I wanted to withdraw 50,000, I have to treat it as if I took out 88,000 and hold the taxes for the federal/state and all that. What I gather they would hold 10% penalty and a 20% federal hold so that leaves me with $35,000. I can then use that to pay off the taxes I'd owe for both the 50k withdraw and the 38k withdraw. Is that true?

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If the $38,000 offset distribution is made separately, it should not be subject to any tax withholding because the mandatory 20% tax withholding is limited by the amount of cash distributed (which would be zero).  However, if the $38,000 offset distribution and a $50,000 cash distribution are made concurrently, the $38,000 would have to be added to the $50,000 in calculating the 20% mandatory tax withholding, resulting in $17,600 of tax withholding and $32,400 of cash paid to you.  If the $50,000 is made separately later, the mandatory tax withholding would be 20% of $50,000 = $10,000.

The entire $88,000 is still includible in the income on your tax return.  These distributions may also be subject to a 10% early-distribution penalty on your tax return depending on your age and whether you have any penalty exceptions that apply.  Whatever is withheld for taxes from any sources of income you receive will be credited against the overall tax liability determined on your tax return.  Tax withholding does not apply to any particular item of income even though a particular item of income was used to calculate the amount to withhold for taxes.