Generally speaking, if you are still employed by the plan sponsor, you are required to pay back the loan through payroll deductions. It’s one of the legal requirements of a 401(k) loan.
Separately, you may not be allowed to take a distribution even though you are older than 59 1/2. Many employers restrict distributions to qualifying hardships while you are still employed with the plan sponsor. You will have to check with the plan sponsor to see if they allow withdrawals.
Loan repayments are not considered tax deductible contributions, even though they increase the plan balance.
If I understand you correctly, I think you are suggesting that you should take a distribution to pay the loan off in a lump sum, and then start making new contributions, instead of using the same paycheck deduction to repay the loan. That would make sense if you are allowed to make withdrawals and if your employer has makes matching contributions. For example, suppose you plan to repay the $5000 loan with monthly payroll deductions of $100; if the plan charges you 5% interest, that would take about 56 months. If you made a lump sum withdrawal of $5000 to repay the loan, and then made new $100 contributions for 57 months, and your employer has a 50% match, then at the end of the 57 months you would have increased your plan contributions by about $9000 instead of $5700.
But is the plan that determines eligibility for matching contributions and withdrawals, not the IRS. You need to ask your employer or their plan trustee.
