401k Loan Rollover

Many people learn the hard way that the worst time to have an outstanding 401k loan is during the 401k loan rollover process. Often the result of changing jobs, the 401k rollover to a new account means that the call on the loan is triggered, and the funds are due. Where do you go from here?

There are two choices for a 401k loan rollover: you can opt to pay the loan back in its entirety, or instead accept the outstanding balance as a distribution.

Paying Back the Loan


When you rollover a 401k, any outstanding loan is called immediately and thus requires repayment of the balance remaining. While 401k loans can be made for durations as long as five years, this term closes after losing or changing jobs, and the term is cut to only 60 days.

Few people can afford to pay back their loans immediately, as otherwise they wouldn’t have the loan in the first place. To pay the loan back, simply pay the company that sponsors your account, and away you go. Most, however, choose the alternative.

Receive the Balance as a Distribution


Should you fail to pay back the loan in its entirety before the end of the 60-day period, you’ll have no other choice but to accept the loan as a distribution. Doing so is not considered a default, nor is it a terrible financial consequence; however, there are some costs with distributions.

Unlike a loan, a distribution is considered income, and if taken before 59 and ½ years of age, a penalty is assessed on the amount of the distribution. Thus, if you were to borrow $5,000 and have paid back all but $3,000, the loan would be effectively written off, and you would have $3,000 charged against your account. Essentially, the money isn’t replaced. You accept the distribution as an early withdrawal instead of a loan, and no further repayments are required.

Be ready to pay, however. Since the distribution is income, you’ll be taxed at that year’s federal income tax rate on top of the 10% early penalty. Thus, a $3,000 distribution would bring a $300 penalty plus your federal and state income taxes on the $3,000. If you are taxed in the 28% bracket and 2% at the state level, you pay a whopping $1,200 in penalties to accept the remainder of the loan balance as income!

401k Rollover
Courtesy of :mymoneyblog.com

No Other Options for a 401k Loan Rollover


There are no other methods available for ending a 401k loan rollover, which happens to be one of the most frequent problems when savers go to move their balances. If possible, exhaust all possible lending opportunities before using your 401k as a personal lender. Unlike your 401k, contracted lending terms from your local bank are fixed length, and they do not require any instant and automatic repayments like a 401k loan rollover so often requires.

As the career of the average worker is slowly divided between more employment opportunities with less time spent at each employer, it is probably best that 401k loans are left only to last resorts.
Tim Ord
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