AboutAllen Expertise Pension questions ONLY. Pension, profit sharing, and 401(k) plan design, installation, administration and actuarial services; rollovers to Individual Retirement Accounts; taxation of retirement plan distributions
Experience Over 35years experience in the pension field
Organizations Various actuarial organizations
Education/Credentials MBA and various professional certifications
Expert: Allen Date: 4/18/2008 Subject: 401K Loan Default
Question In June 2004 I took out a 401K loan for a new home purchase, in September of 2007 I received a letter that payments were not consistant, and that since January 2006 until September 2007 no payments were made and no lump sum was received that I would be receiving a 1099 for the balance of the loan. Since, this was suppose to be my responsibility to check that payments were being made. I checked with HR and asked why without my permission payments were stopped, they stated a computer glitch. Since this point I did report the 1099 on my taxes this year, but they have restarted the loan as of October 2007. Since, these repayments are after tax on my pay, shouldn't this loan not have to be repaid at this time, since I would be paying double tax on the same money?
Answer First of all, if it were me I would not be happy with a computer glitch causing me to pay current taxes and I would discuss with the company what they are willing to do about this. I would be especially concerned because you should have paid a 10% excise tax on the unpaid loan amount because the money was "received" before age 59 1/2. This tax is in addition to the income tax that was due. If you didn't pay the excise tax, you will probably receive a letter from the IRS. At the very least, your company should bonus you the amount of the excise tax plus the taxes you will have to pay on this bonus.
Second, if the loan went into default in January 2006, you should have received a 1099 for 2006, not 2007. I don't think the IRS will complain since you paid the tax. But again this is very sloppy administration by whoever is administering the plan.
More importantly, regarding your main question - you do have to continue to pay off the loan. It's an obligation to the plan. However, you will receive what is known as basis for the amount of income that was taxed. When you receive a distribution from the plan you should only pay income tax on the amount received less the amount that was already taxed. In other words if your account is worth $100,000 and you already paid tax on $25,000, you should receive two 1099s - one for $75,000 which is coded to show that it is taxable and one for $25,000 coded to show that it is not taxable. You should keep a record of the amount you already paid tax on to make certain you do receive two 1099s.
