Getting a 401(k) loan is a great idea, generally speaking. A 401(k) loan, if allowed by the rules of your 401(k) plan, is a withdrawal from your account that you repay with a modest interest rate. The interest paid goes to your account. You pay yourself the interest. There is no tax consequence for a 401(k) loan that is repaid. The risk of a 401(K) loan is the costs involved if something prevents you person from repaying the loan as agreed.
You raise the question what happens if you fail to repay a 410(k) loan. The answer is simple and logical -- the IRS considers an unpaid 401(k) loan a distribution and the rules for a 401(k) distribution apply for the date that you took the 401(k) loan. If you are employed and are less than age 59½ and are not suffering a hardship, then you will pay a 10% penalty tax plus your tax rate for the amount of the loan/distribution.
If you have a hardship that qualifies, then you will not have to pay the 10% penalty tax. Keep in mind that what you define as a hardship and what the IRS defines as a hardship may not be the same. See the IRS Web page 401(k) Resource Guide - Plan Participants - General Distribution Rules and IRS Publication 575 to learn more about 401(k) loans, hardship rules, and loans treated as distributions.
I hope this information helps you Find. Learn & Save.
Best,
Bill
Bakersfield, CA | February 08, 2012
February 08, 2012
Complete a 1040, or consult with a tax preparer, to learn a precise answer to your question.
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