401(k) Loan Takes You Out

Jennifer says her husband lost his job after they took out a 401(k) loan to pay off credit card debt. Dave tells Jennifer they're probably going to have a $10,000 tax bill next year.

QUESTION: Jennifer in Cincinnati is calling because her husband lost his job after they took out a 401(k) loan to pay off credit card debt. They owe $36,000. Dave tells Jennifer they’re probably going to have a $10,000 tax bill next year.

ANSWER: You have 60 days from the time he lost his job to pay this loan. If you don’t, it’s considered an early withdrawal by the IRS, and you’ll get hit with your tax rate plus a 10% penalty. If it’s been three months since he lost the job, then the loan is due. It’s not up to the company to determine that, it’s the IRS. You just bit a $10,000 tax bill.

My guess is that you’ll end up cashing out that much of the 401(k) to pay the loan off. Since you’ve already gotten hit with the penalties and taxes, then you might as well do that. Go see your tax professional to double-check that.

That’s a good warning for everyone else. When you take out a 401(k) loan, you’ll end up leaving the company somehow. You will get fired or laid off or die. When you leave, your loan is due in full. If it’s not paid within 60 days, it is considered an early withdrawal. It’s as if she took $36,000 out of the 401(k) early. That makes it subject to your tax rate, usually 20 to 30%, plus a 10% penalty. Jennifer will get hit somewhere in the 40% range of $36,000. Do not ever borrow from your 401(k) under any circumstances.

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