Under the newly-passed Tax Cuts and Jobs Act of 2017 (TCJA), there has been a slight change for folks who have taken loans from their workplace retirement plan and subsequently left the job before paying the loan back. These 401k loan distributions (as they are known) are immediately due upon leaving the job, considered a distribution from the plan if unable or unwilling to pay it back. This results in a taxable distribution, plus a 10% penalty unless you’re over age 59½. (You could avoid the 10% penalty as early as age 55 if you’re leaving the employer.)
The distribution could be mitigated by rolling over the same amount of the distribution into an IRA within the regular 60-day limit. The new provision in TCJA allows an extension of this time, up to the due date of the tax return for the year of the distribution. This applies to 401k, 403b, and 457 plans equally, but we’ll just call them 401k loan distributions for brevity.
For example, Willard has a loan with a balance of $10,000 against his 401k plan. He’s been paying it back regularly, per the plan rules. In 2018 he leaves the job, but he doesn’t have enough money to pay back the loan right away. So his old job’s 401k administrator considers this a distribution from the plan, and since Willard is 50 years old, there are no exceptions to apply. This will result in a 1099R at the end of the tax year from the 401k administrator, indicating a fully-taxable distribution with no exceptions applied.
In the olden days, Willard could still avoid the tax and 10% penalty on the distribution if he could somehow come up with $10,000 within 60 days and roll that money into an IRA. In the new world of TCJA, Willard doesn’t have to come up with the money within 60 days: he has until April 15, 2019 to come up with $10,000 and roll that money into an IRA. This will avoid all tax and penalty on the rolled-over distribution.
Keep in mind that this only applies to 401k loan distributions that occur as a result of the employee terminating his employment or the company terminating the retirement plan. If the plan loan distribution occurs because the employee has not kept up with his payments against the loan, this is still considered a distribution subject to ordinary income tax and the 10% penalty if applicable. This type of distribution has no way to avoid the tax and penalty by a rollover.
Sterling Raskie, MSFS, CFP®, ChFC®
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And if you’ve come here to learn about queuing waterfowl, I apologize for the confusion. You may want to discuss your question with Lester, my loyal watchduck and self-proclaimed “advisor’s advisor”.
I am in the same situation as described by your example. But how do I put the money back to the new IRA account? IRA account only accept $5500 per year. In your example for $10,000, how does it work? Thank.
You can put money into an IRA account in 3 ways:
1. Annual contributions (new money that has not been in a deferred account such as an IRA previously). This is limited to $5,500 per year plus the $1,000 catch up if over age 50.
2. Direct, trustee-to-trustee rollover. This is money that was in an IRA or 401k (or other deferred account) and you are rolling it over into the IRA. There is no limit on the amount you can rollover.
3. Indirect rollover. This is money that was in an IRA or 401k (or other deferred account) and has been withdrawn in cash. Within 60 days you can roll it into another IRA, 401k or other deferred account, or back into the original IRA. There is no limit on the amount of money that you can rollover. There is the 60-day limit between the withdrawal from the “origin” account and the deposit into the “destination” account, and there is the limitation that you can only do a rollover like this in IRAs once per year.
The answer to your question is – assuming you’re doing a #3 indirect rollover, and you just deposit the funds back into an IRA (or the original IRA) within 60 days.
Most plans allow the terminated participant to just keep paying their loan back on the same bi-weekly, monthly, or quarterly payback schedule electronically through their checking or savings account
Some plans do allow an extended payback period.
However, many plans do not allow an extended payback period, and when they do not allow it, the loan is considered a distribution upon termination, which will be included as income unless rolled over.
True. I guess it is ultimately the participant’s responsibility to understand the loan policy of their employer’s plan before taking a loan so that they know the ramifications of what happens if they terminate employment while they have an outstanding loan. Keep up the great posts! Thanks!
There is an exception to the 10% penalty on 401k distributions if you are age 55 and leave the employer,
Of course – and you know, I was going to put that exception in the article but decided to leave it off at the last minute since I had not confirmed how the date of the distribution works. As always, you’re absolutely correct, and I’ll update the article to reflect this exception.