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Returning Member

Does paying the taxes and penaties satisfy a 401k loan?

I took out a 401k loan awhile back and have about a 9000 balance. Then Covid happened and I lost my job (my company completely went out of business). I rolled over my 401k into an IRA and assumed that my loan would be paid with an offset distribution when the funds were rolled. However, it wasn't. I now still have a loan balance but no other funds in the account. I did not even realize that I still owed the loan until months later when I received an email telling me that the payment was overdue.

 

I was told that I would receive two 1099-R Forms (one for the distribution and one for the defaulted loan) so what does that mean? I will pay penalties and taxes on the 9000? But that doesn't satisfy the loan right? Or does it since I borrowed from myself? Do I have to write a check and pay off the loan? I have been racking my brain all day trying to figure out how I was allowed to roll over the money without satisfying the loan. I am totally confused.

4 Replies
Level 15

Does paying the taxes and penaties satisfy a 401k loan?

See this FAQ.

https://ttlc.intuit.com/community/retirement/help/what-happens-if-i-have-a-401-k-loan-but-later-lose...

**Disclaimer: This post is for discussion purposes only and is NOT tax advice. The author takes no responsibility for the accuracy of any information in this post.**
Returning Member

Does paying the taxes and penaties satisfy a 401k loan?

I read this. Thank you. But I am still not clear on whether I am required to pay the balance due. The FAQ you referred to states, 

"A plan may provide that if a loan is not repaid, your account balance can be reduced or offset by the unpaid portion of the loan."

But as I stated before I rolled the funds into a IRA so there's nothing left to off set the balance due. So I guess my specific question is in addition to the taxes and penalties does the actual loan balance have to be repaid? 

Level 15

Does paying the taxes and penaties satisfy a 401k loan?

When did you stop making payments on the loan?  The CARES Act allows any loan repayment required to be made between March 27, 2020 and December 31, 2020 was permitted to be delayed for one year, so failure to make a payment during this period would not result in a default if the plan permitted suspending repayments.  Since a default was declared, apparently the plan did not permit suspension of repayments.

 

If a default was declared in 2020 and you will be receiving a code L Form 1099-R.  Assuming that you are under age 59½, box 7 of the Form 1099-R will include code 1 in addition to the code L.  Because you lost your job due to COVID-19, you can declare the deemed distribution to be a Coronavirus-Related Distribution, avoiding the 10% early-distribution penalty and allowing the tax on the deemed distribution to be paid over 3 years by reporting it on the yet-to-be-implemented Form 8915-E.

 

A deemed distribution does not satisfy the loan.  The loan is still part of your 401(k) and you are still responsible for repaying the loan.  It will continue to accrue interest until fully repaid.  Repayments will become after-tax basis in your 401(k), so you will not owe tax again on the amount that became a deemed distribution when later distributed from the 401(k).

Level 15

Does paying the taxes and penaties satisfy a 401k loan?

Because of the reference to it as being a defaulted loan, I'm assuming that the plan did not suspend repayments.  I suppose it's possible that that reference is inaccurate, that the loan was not in default due to suspension of repayments and that the plan is now making an offset distribution, but that seems unlikely given the timing.  Check with the plan to be sure that it is being reported as a deemed distribution rather than as an offset distribution.

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