401K Loan - Defaulting Impacts (1 Viewer)

[LarryAllen'sJockstrap]

I'm not a finance guy, so could someone please tell me the impacts of defaulting on a 401K loan. For example, say there is 25K on the principal of the 401K loan, but the account holder still is contributing to, and has a lot of money remaining in the 401K account (I.e., 250K+).

If, in this situation, the account holder loses their job and is unable to payback the 25K principal owed (to themselves?) in the 60 day timeframe, what are the consequences? I know there is an early withdrawl penalty and I believe the principal gets taxed as income. Do the penalty and taxes get taken out of what is left in the 401K (the 250K). If not, what happens? Does the 25K default impact the account holder's credit score? What does that 25K loan end up costing the account holder total in the long run?

TIA.

 

[BobbyLayne]

No impact on your credit score. Employers do not report loan defaults to credit reporting agencies. The larger issue is the tax liability.

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.

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.