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nicnat100
New Member

Is it better to stop 401k loan payments this year as my severance and other payouts were taxed at a higher rate and so early withdrawal tax & penalties may be absorbed?

I got 401k loan in 2016 and got laid off in mid 2017. I have been making regular loan repayments but as I haven't gotten another job yet, these payments are becoming a challenge. I know it will be converted into a withdrawal once payments stop so I am wondering whats the best way to decrease my tax liability if this should happen. I assume that the  withdrawal tax and the penalty will be incorporated into the 1040 tax liability calculation in some way (and I don't pay the penalty separately). As I received severance-related payments which were taxed at a higher rate, I am thinking that those may absorb some of the impact of the withdrawal taxes and penalties rather than waiting until next year to stop making loan repayments. 

1 Reply
Opus 17
Level 15

Is it better to stop 401k loan payments this year as my severance and other payouts were taxed at a higher rate and so early withdrawal tax & penalties may be absorbed?

 While it might be true that excess tax was withheld from your severance, meaning that you can get a refund, it is also true that next year's tax rates will be about three percent lower for most taxpayers. You will ultimately pay less tax if the loan is deemed a 2018 distribution instead of a 2017 distribution.  (If you already made your December payment, it may be too late to have it treated as a 2017 distribution anyway.)

Don't forget you will still owe a 10% early withdrawal penalty unless you are over age 55, so it may still be beneficial in the long run to pay off the loan and leave the money to grow to your retirement.  

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*

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