@catspaw21 wrote:
i tried that. it seems not to be accepting it. i may delete it and just try to re-enter it again. But at least now i know why it wasnt giving me the three year option, so thank you.
If you have a loan from your 401(k) and you default on the loan payments, you have a "deemed distribution." That's code L. This distribution is subject to a 10% early withdrawal penalty unless you are over age 59-1/2. It can't be offset by performing a rollover to a new plan or by repaying the loan. The tax can't be extended over 3 years because the deemed distribution is not covered under the CARES act. Unfortunately, you just owe the tax.
If you separated from service, so the loan payments were not made, I believe that would be an "offset" distribution, and you could avoid the tax and penalty by making a rollover contribution before the deadline of your next tax return (which was May 17 unless you got the extension). But deemed distributions are not eligible for rollover.
You are just stuck with the tax and penalty, sorry.
Repayments of what? Why do you need to explain it? To who? Just enter the W2 and/or 1099 income you got.
No one can see your screen or your tax return. We do not know what repayment you are referring to or what balance you are saying that you were taxed on. Please explain. We do not know how to help since we cannot figure out what you are talking about.
sorry obviously the system did not repost the entire question! i had loans from my 401k that i was making repayments through my paychecks.
Did you get a 1099R reporting the unpaid loans as Distributions?
the system does not seem to be giving me the option to break the taxes down over the next 3 years either
Code L does not allow the option to spread it out over 3 years since you took the loan out before 2020.
And if you follow the screens you can get rid of the penalty ...
i tried that. it seems not to be accepting it. i may delete it and just try to re-enter it again. But at least now i know why it wasnt giving me the three year option, so thank you.
@catspaw21 wrote:
i tried that. it seems not to be accepting it. i may delete it and just try to re-enter it again. But at least now i know why it wasnt giving me the three year option, so thank you.
If you have a loan from your 401(k) and you default on the loan payments, you have a "deemed distribution." That's code L. This distribution is subject to a 10% early withdrawal penalty unless you are over age 59-1/2. It can't be offset by performing a rollover to a new plan or by repaying the loan. The tax can't be extended over 3 years because the deemed distribution is not covered under the CARES act. Unfortunately, you just owe the tax.
If you separated from service, so the loan payments were not made, I believe that would be an "offset" distribution, and you could avoid the tax and penalty by making a rollover contribution before the deadline of your next tax return (which was May 17 unless you got the extension). But deemed distributions are not eligible for rollover.
You are just stuck with the tax and penalty, sorry.
thanks. it certainly seems there is no way around it. i have the extension. i was hoping to make a payment towards the loan - but i can't do that and pay the taxes too!
@catspaw21 wrote:
thanks. it certainly seems there is no way around it. i have the extension. i was hoping to make a payment towards the loan - but i can't do that and pay the taxes too!
The other thing about paying back the loan is you don't get a tax break for it, but it creates a taxable basis in the 401(k). (This can get complicated to explain.)
For example, suppose you have $100,000 in your plan in a S&P index fund, and you borrow $50,000. Now your plan assets are a $50,000 index fund and a $50,000 loan to yourself; the loan is counted as a plan asset. Even though you get the deemed distribution, the loan is still considered a plan asset. But now, if you pay it off, that becomes a taxable basis in the account. Suppose you manage to pay back the entire loan over time. You don't get any tax deduction for repaying the loan, but now your plan assets consist of $50,000 of pre-tax and $50,000 of after-tax assets. In the end, that means that when you make withdrawals in retirement, your withdrawals would only be 50% taxable instead of 100% taxable.
So repaying the loan will still ultimately be to your long-term benefit, just in a different way. And unfortunately you are stuck this year. You should ask the plan administrator if there is any time limit to making loan repayments. You might consider temporarily stopping your pre-tax contributions and making after-tax loan payments instead, unless you would lose out on a match by doing that.
Then if you separate from service (quit, retire, get fired) you have a whole other group of options for your 401(k) money.
It can get complicated, and professional advice might be helpful going forward. Good luck.
Repaying the loan to avoid taxes is not an option since the 1099-R was coded L and not the new M.
Thank you, your answer makes a lot of sense. If I stopped my pre-tax contributions, I would lose out on the match. I may considering repayments of some kind still, simply that I may need to borrow again from my 401k and the amount I would be able to borrow would be substantially more than the repayment. I know it is not the best option, but I am in the middle of a divorce and may also soon be relocating out of state and my options are limited. As for the long term benefits as you stated, I will be 59 and a half in February 2021 so maybe I will be able to reap them sooner rather than later. Thank you again.
@catspaw21 wrote:
Thank you, your answer makes a lot of sense. If I stopped my pre-tax contributions, I would lose out on the match. I may considering repayments of some kind still, simply that I may need to borrow again from my 401k and the amount I would be able to borrow would be substantially more than the repayment. I know it is not the best option, but I am in the middle of a divorce and may also soon be relocating out of state and my options are limited. As for the long term benefits as you stated, I will be 59 and a half in February 2021 so maybe I will be able to reap them sooner rather than later. Thank you again.
You've got a complex situation. You may want to see a proper financial planner. Here are some additional thoughts that may be helpful.
If you can reduce your 401k contributions and still get the match, you might want to make loan repayments with the rest. For example, if the maximum match is achieved if you contribute 5%, but you are currently contributing 8%, you could put that other 3% toward loan repayments instead of toward new contributions. You won't get an immediate tax deduction, but it will reduce your taxable withdrawals later.
If you can reduce your 401k contributions and still get the match, you might want to contribute to a private Roth IRA rather than making either new contributions to the 401(k) or paying back the loan. However, depending on your other income, you might not be eligible to contribute to a Roth IRA. The advantage of a Roth IRA (if you are eligible) is that you can withdraw the principle contributions at any time for any reason without penalty. The disadvantage is that you can't withdraw earnings until you are over age 59-1/2 AND the Roth IRA has been open 5 years.
I would not contribute to a Roth option within the 401k in your situation. You won't be able to withdraw ANY money as long as you are still employed by that employer, unless you meet the definition of a "hardship" withdrawal, and even then your earnings will be taxed if you have owned the Roth option for 5 years (I think--early withdrawals of Roth option 401ks are extra-complicated.)
In fact, turning 59-1/2 does not help you at this point unless you have other retirement funds not in a qualified workplace plan, because you can only withdraw from the workplace plan after separation. (And, if you do separate from service, you can withdraw from a 401k without penalty at age 55 or more, not age 59-1/2.)
If you have money now but think you might need it later for emergency spending, I would try putting money in a Roth IRA if you are eligible. Failing that, a regular broker account might not be too bad because there are no penalties and you only pay tax on your gain. A third strategy would be to push money into the pre-tax 401k knowing that if you take a loan again and default, you won't pay the additional penalty after this year. It can be quite complicated as you see. Good luck.