Expert: Allen - 8/4/2010

Question
I have an outstanding pension loan from my previous employer totaling $12,421.24.  I recently received a notice that I must begin making payments of $528.23 per month or the loan will be declared a distribution.  I cannot afford to make these payments at this time.  I have been told that even if I choose not to make the payments and the amount is reported as a distribution, I will be required to pay federal and state (NJ) taxes on the distribution and I will still have to pay the loan back as long as I have an active pension plan.  I am wondering if I should just take my chances and hope that my income tax refund for 2010 will cover the taxes on the distribution and then roll over the remaining balance of my pension into an IRA to avoid having to pay the money back.  However, because I am only 39, I am not sure how the 10% penalty will be handled for early withdraw.  Can this also be deducted from my income tax refund or will I have to pay this separately?  I really need sound advice on what to do, attempting to make the payments at this time may cripple my house financially.  I took out the pension loan due to my husband's job loss and he is still collecting unemployment therefore we cannot afford an additional expense of this amount at this time.

Answer
The amount in your account other than the loan can be rolled to an IRA. However, as you mentioned, the unpaid balance of the loan will be considered a taxable distribution. You will have to pay federal income tax, state income tax and the 10% excise tax. The loan will be considered taxable at the end of the second quarter in which you did not make payments. So if you stop payments now, it will be considered as taxable at the end of December.

I'm sorry to hear about your financial situation and I understand that paying $500+ is very difficult. However, if at all possible, try to continue making payments. Perhaps you can borrow enough to pay off the loan. Then you can repay the borrowing with your tax refund. One thing though, do not borrow on your credit cards - that would put you in a deeper hole.

Good luck. I'm sorry that I can't give you a better answer.