Is a 401 (k) Loan Reportable on Your IRS Income Taxes? | Finance


If you participate in a 401 (k) workplace pension plan, you may be able to borrow money from the account, assuming your employer allows such loans. Not all employers do this, so it is necessary to check with the plan administrator first. 401 (k) loans must follow strict IRS rules regarding repayment amount and period, and non-repayment on time can trigger a 401 (k) loan tax and 401 (k) loan penalty. ).

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You don’t report a 401 (k) loan on your tax return unless you are in default.

401 (k) IRS Loan Rules

To receive a loan from a 401 (k) the plan must allow it, you must be a plan participant and you must have a positive earned balance in your account. Your employer can delay your participation in their 401 (k) for up to one year from the date you start, and you must be at least 18 years old.

Once you start participating, you can choose to defer a portion of your income by contributing to your 401 (k) up to federal limits. Your contributions are excluded from your annual taxable income. Employer contributions to your 401 (k) are tax exempt for you and tax deductible for your employer. Your contributions vest at 100% immediately (that is, you can withdraw them all if you separate from your employer), but employer contributions may follow a vesting schedule that delays your ownership. Certain employer contributions are not eligible for the loan, whether acquired or not.

401 (k) Loan repayment

The IRS will consider your 401 (k) loan to be a reportable taxable distribution, unless you meet one of these conditions:

  • You repay the loan within five years.
  • You use the proceeds to buy or build your primary residence.

Even if you meet either of these two requirements, the IRS will process your total loan balance that exceeds the lesser of $ 50,000 or half the value (but not less than $ 10,000) of your account balance. acquired as a taxable distribution. If you have already taken out a loan, you will need to reduce the limit by $ 50,000 up to the highest outstanding balance during the one-year period ending the day before the new loan less the outstanding balance on the date. to lend again.

Avoid 401 (k) loan repayment taxes

To avoid a taxable distribution, your loan repayments must be paid in substantially equal amounts at least quarterly. This requirement can be suspended for up to one year if you go on unpaid leave, although this does not affect the final due date or minimum quarterly payment amount. However, you may benefit from a longer payment holiday and an extended repayment period if you go on active duty in uniformed services.

If you are using the loan to buy or build your primary residence, you do not have to meet the five-year repayment period. The plan will specify the maximum repayment term, which is often 15 years.

401 (k) Interest on loan

You have to pay interest on your outstanding loan balance. Interest is deposited into your 401 (k) account, which means you pay yourself interest. The interest rate cannot be lower than the rate you would pay a local commercial lender for the same loan. The IRS generally considers that an interest rate equal to the prime rate plus two percentage points is sufficient to meet the rate requirements.

401 (k) loan in default: deemed distribution

A deemed distribution is one way for your plan administrator to deal with a delinquent 401 (k) loan. This is not a cash flow and the distribution amount cannot be transferred to another qualified account or IRA. The sole purpose of a deemed distribution is to determine the amount of tax and penalty you will have to pay on the overdue amount.

You could trigger a deemed distribution if you quit your job and have an outstanding loan balance that you cannot pay off immediately. If you can find the default amount within 60 days, you can pay it into another qualified account or IRA, subject to annual limits. It is not a reversal. The contribution will reduce or eliminate income tax due in respect of the distribution, but will not affect any tax penalty.

401 (k) loan in default: compensation of the plan

Under this method, your account balance is offset (reduced) by the default amount. If you can collect the clearing amount within 60 days, you can transfer it to an IRA or other qualified account, thus avoiding the tax and penalty. There is no limit on the amount that can be carried forward, up to the total amount of the compensation.

If the plan compensation results from the plan interruption or termination of employment, you have until the federal income tax filing date, including any extensions, to rollover.

If you wish to remedy a deemed distribution, you can make any missed refunds to the plan even after the deemed distribution has taken place. Refunds are after tax, and they are added to the tax base of your 401 (k) account. In contrast, pre-tax contributions do not increase the tax base of the account. You can withdraw money tax-free from your 401 (k) up to the base amount, if applicable. Unless your 401 (k) has a designated Roth component, your account is unlikely to have a base.

Declare a loan as a distribution

If you do not meet the terms of your loan, you will face taxes and a possible 401 (k) loan penalty. The overdue amount will be treated as a taxable distribution, and if you are under 59.5 years of age, you may be subject to an early withdrawal penalty of 10%.

The distribution will be indicated on Form 1099-R with a distribution code of “L.” Include this amount on Form 5329 if you have to pay the tax penalty on an early distribution, and attach the form to your annual tax return. Add the tax penalty to Schedule 4 of IRS Form 1040 and in the Other Taxes section of Form 1040. Add the amount of the distribution to the Income section of Form 1040.

Roth 401 (k) loans

Your employer may offer a designated Roth account under the 401 (k) plan and may authorize loans from the Roth account. The Roth account contains the contributions on which you have already paid tax, as well as the income from those contributions.

If you default on a Roth 401 (k) loan, you will only pay taxes and penalties on the portion of the loan allocated to income – contribution distributions are tax exempt. The earnings distribution penalty is triggered if the distribution occurs within five years of the initial contribution or, subject to certain exceptions, before the age of 59 ½.

401 (k) Loan Vs Withdrawal

Borrowing on your 401 (k) has some advantages over withdrawals. The money you borrow will be paid back, with interest, so you won’t suffer a permanent loss of tax-sheltered retirement funds. You don’t pay taxes or penalties on 401 (k) loans unless you don’t pay back in full within the loan period, which is typically five years. When you borrow to finance the construction or purchase of your primary residence, it may take longer to repay.

However, the amount you can borrow is limited, with an absolute limit of $ 50,000. If you need more than the loan amount allowed, you may need to resort to a 401 (k) withdrawal, if available. You will have to pay taxes, and possibly a 10 percent penalty, on the withdrawal, and 20 percent will be withheld for taxes. If you are withdrawing money due to financial hardship, you will first need to take out the maximum loan available on your 401 (k) and exhaust all other sources of funds.


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