Way to avoid 60 day repayment of 401(k) loan when leaving job?

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FuzzyButtons
Posts: 24
Joined: Fri Dec 05, 2014 12:28 pm

Way to avoid 60 day repayment of 401(k) loan when leaving job?

Post by FuzzyButtons » Tue Feb 23, 2016 2:54 pm

It has always been my understanding that if you have an active loan from the 401(k) plan of your employer when you leave service, you have 60 days to pay back that loan or the remaining balance will be considered a distribution subject to income tax and penalty, if appropriate. But I have a coworker who recently left employment in this situation, and she was told by her 401(k) custodian that there was a way around this.

Specifically, she was told to not make any payments on the loan once she has left the company. This would put the loan in "default", but since the default was to herself there would not be any reporting to a credit agency. She could maintain this state for as long as she wanted. However, when she finally did make a payment on the loan, that payment would need to be for the whole balance. If it was a partial payment, then the rest of the loan would be considered a distribution. But as long as she paid it in full, she could wait years to make the repayment. All of this also assumed that she would not attempt to roll-over the 401(k) to another account.

Has anyone heard of this tactic before? I strikes me as a bit of a "dodge" of the IRS requirements - taking advantage of the fact that the custodian's system doesn't acknowledge the situation until a payment is received. But the custodian in this case is Fidelity - and it seems like they would know the rules.

johnubc
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Re: Way to avoid 60 day repayment of 401(k) loan when leaving job?

Post by johnubc » Tue Feb 23, 2016 3:00 pm

I have never heard of it and would not take that advice. What I have heard is that if you do not pay off the loan, you will be issues a 1099-R for a distribution.

wolf359
Posts: 1965
Joined: Sun Mar 15, 2015 8:47 am

Re: Way to avoid 60 day repayment of 401(k) loan when leaving job?

Post by wolf359 » Tue Feb 23, 2016 3:04 pm

Your original understanding is the same as what the IRS publishes. https://www.irs.gov/Retirement-Plans/Re ... ng-Loans#4

If you don't pay it back in 60 days, it is considered a distribution.

The IRS does talk about paying it back in full if you want to reverse the deemed distribution. https://www.irs.gov/Retirement-Plans/Re ... ng-Loans#7

The verbal advice is also contrary to what Fidelity publishes. https://www.fidelity.com/viewpoints/ret ... 401k-loans

Topic Author
FuzzyButtons
Posts: 24
Joined: Fri Dec 05, 2014 12:28 pm

Re: Way to avoid 60 day repayment of 401(k) loan when leaving job?

Post by FuzzyButtons » Tue Feb 23, 2016 3:43 pm

wolf359 wrote:Your original understanding is the same as what the IRS publishes. https://www.irs.gov/Retirement-Plans/Re ... ng-Loans#4

If you don't pay it back in 60 days, it is considered a distribution.

The IRS does talk about paying it back in full if you want to reverse the deemed distribution. https://www.irs.gov/Retirement-Plans/Re ... ng-Loans#7

The verbal advice is also contrary to what Fidelity publishes. https://www.fidelity.com/viewpoints/ret ... 401k-loans
I note that the Fidelity repayment statement has a footnote with the boilerplate "Plan rules may vary". Perhaps this is something that an individual plan could allow? Seems unlikely to me - usually when the IRS allows plans to differ it's only if they become more restrictive, not less.

The link you provided about remedying a default after there has been a deemed distribution sounds like what she was describing. Still, that would imply that the deemed distribution had happened, and so the tax would have to be paid. This would just be a way to get the money back in and get a refund of the tax later? It also applies to 401(k) loans generally, and might be superseded by the rules about termination of service.

Just musing out loud here. Good things to think about, I'll pass those links along. Thanks!

CT-Scott
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Joined: Sun Feb 22, 2015 3:01 pm

Re: Way to avoid 60 day repayment of 401(k) loan when leaving job?

Post by CT-Scott » Wed Feb 24, 2016 2:11 pm

Yes, it sounds suspect to me.

If your (former?) coworker is in a situation where she cannot afford to pay back the loan, but wants to avoid paying the 10% penalty, and assuming that her total 401k balance is high enough and she is now employed somewhere else where she could rollover her 401k and take out a new loan, she could try to secure a short-term loan (even via a credit card cash advance promo) to pay back the loan, rollover the 401k to her new employer, and then request a new loan which she could use to pay back the short-term loan.

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