, Answering FAQ'sTurboTax Employee
Many companies allow workers to borrow a portion of the money they have saved in their 401(k) retirement plans. While you are employed at the company, these loans must be repaid within five years.
If you have taken out a loan from your 401(k) retirement savings and then quit or lose your job, you must repay the loan, typically within two months. If you can’t repay the loan, it will be treated as an early withdrawal and depending on your age, you could be hit with a big tax bill and a penalty.
If the loan is not repaid, you should receive a Form 1099-R. The form lists the amount of the early withdrawal (Box 1) and should show how much of that amount is taxable income (Box 2a).
Following IRS rules, TurboTax calculates both the taxes and the 10 percent penalty and applies it to your return.
If you quit, are laid off your job, or your company closes its doors before you repay your loan, the IRS will consider your unpaid 401(k) loan balance an “early distribution” of retirement savings. If at all possible, repay the balance before the repayment deadline to avoid the taxes and penalty.
The loan’s outstanding balance will be treated as income to you and you will be required to pay taxes on it. If you have a loan balance of $20,000, you could owe federal income taxes ranging from $2,000 to $7,000 or more, depending on your tax bracket. For example, if you are in the 28 percent tax bracket, your taxes would be $5,600. State taxes could also apply.
Distributions may be fully or partly taxable. If your plan includes nondeductible contributions that you made, that portion may not be taxed. However, it would still be subject to a penalty. TurboTax will ask questions to see if any of your distribution might be nondeductible.
If you are under the age of 59 ½, You will also be charged a 10 percent early withdrawal penalty. Using the example of a $20,000 loan, the penalty would be $2,000 in addition to the income tax.
To avoid further taxes and penalties (if under age 59 ½), keep any remaining money in your 401(k) account (if your company allows) or roll it over to an IRA or other retirement account.
Taking a loan against your 401(k) is different than taking a hardship distribution. Read Withdrawing Money From Your 401(k) Plan As a Hardship Distribution, for more information.