Generally speaking, a 401k loan is one of the safest, easiest, and most reliable ways to take out an emergency loan without racking up considerable interest. There are, however, some possible pitfalls. Most importantly, if you leave your job or are terminated, this loan could potentially cost you your retirement.
When you leave a job or company after taking out a 401k loan, you are responsible for paying back that loan at a far faster rate. If you don’t pay the loan in the time allotted, you may find yourself for a hefty tax fee.
Before leaving your job, you may want to consider the effect that it will have on your bank statements come tax season. In this article, I’ll be addressing confusion around what happens to a 401k loan after you’ve left your original job, as well as steps you can take to pay it back as quickly as possible.
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How Long Do I Have To Pay My 401k Loan?
Typically, a 401k loan is a much safer option than many typical loan types. Because your 401k provider has your money in hand, they can offer a loan at a much lower interest rate, saving you money. If you lose that job, you may find yourself responsible for returning that money much more quickly than expected.
A typical 401k loan must be paid back within 5 years unless the loan was rolled into a mortgage. Payments must be made quarterly. However, if you lose your job, you may be required to repay that total loan amount in as little as 60 days unless you take advantage of the Tax Cuts and Jobs Act.
Tax Cuts and Jobs Act
Traditionally, employers and employees are responsible for working out the intricacies of paying back a 401k loan after moving jobs. After recent government action, however, employers may temporarily be able to buy themselves extra time.
Under the Tax Cuts and Jobs Act, employees are given until the day they file their next round of taxes to pay back this loan.
This policy means that if an employee were to lose their job in August of 2021, they would be given until the next fiscal year to repay the money on their previous 401k loan.
There are a few things to keep in mind regarding the Tax Cuts and Jobs Act.
The first is that, while this may be a temporary relief, this act is only guaranteed to be in effect for another few years. If you plan to leave a job after 2025, this reprieve may fall outside your eventual goals.
Another thing to consider is that a loan on your previous 401k may leave you in a temporary state of limbo regarding what to do with the rest of the money in that account. Depending on your employer’s plan, you may be unable to transfer this money into an IRA or new employer plan while outstanding loans remain.
What Happens to My 401k Loan if I Don’t Pay?
The stability of your 401k loan comes from the fact that your loaning agent knows that the money to pay them back exists. If you don’t pay willingly, they’ll take alternate measures to get their money back.
If you don’t pay a 401k loan, the employer will issue IRS form 1099-R, distributing the money. From this point, the money from the loan will be considered an early withdrawal from your retirement account, and you’ll be responsible for paying a ten percent tax rate.
Depending on how much money was left on your loan, this ten percent fee may be too much of a hit on your retirement for you to bear. Luckily, there are a few options available to alleviate this burden. Let’s take a look at those options.
Plan Ahead
If you know in advance that you plan on leaving your job in the future, you’ll need to budget to pay as much of this loan off in advance as possible. Now is the time to cut any potential expenses and pour as much money into the loan as you can.
Even if you are unable to pay off your 401k loan before leaving your job fully, that ten percent fee is going to hurt far less on an 8,000 dollar loan than it might have on the original 20,000 dollar loan.
File for an Extension on Your Taxes
I’d previously mentioned the Tax Cuts and Jobs Act; this is the time to get savvy and take advantage of this to the full extent that you can.
When budgeting to pay back this loan, remember to file an extension on your taxes using form 4868 through the IRS. In doing so, you’ll be extending the amount of time you have to figure out this loan by several months.
One thing to keep in mind when taking this option is that, in doing so, you’re expanding the amount of time you have to file paperwork, but the money you have to pay is not reduced.
Consider a Loan
When considering taking out one loan to pay back another, you need to consider a number of elements.
Before taking out any additional loans, consider the amount you’ll lose by simply paying your taxes. If you are only hit by a penalty of a few hundred dollars, it may not be worth taking an additional loan, especially if it comes with a high-interest rate.
If you are still looking to buy yourself time to pay back your 401k loan after quitting a job, you may consider transferring the balance into a zero percent transfer credit card.
In doing so, you’ll buy yourself time, but be wary when taking this route. Not all credit cards allow a transfer from a 401k account without additional fees, and you are highly unlikely to be able to keep a low-interest rate after this maneuver.
Another option for those who simply stepped from one job to another is to pay off the original 401k loan using one from their new employer’s 401k plan.
This plan is likely the easiest, most secure way to pay off the loan. Unfortunately, it’s also far from a sure possibility. Most employers require employees to work a set amount of time before taking a loan of any sort from their 401k balance.
Hire a Financial Advisor
If you have the money available, it may be in your best interest to hire a financial advisor.
It’s very likely that as you change from one job to another, you’ll face more than just the question of this particular loan. You’ll also need to consider what to do with the money that’s left, whether that means transferring it to an IRA or a new employer account.
The financial health of your 401k is not to be handled lightly, particularly if you’ve invested thousands of dollars and years of work into maintaining it.
Author’s Recommendations: Top Trading and Investment Resources To Consider
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Conclusion
There’s no way around it. Handling large sums of money can be scary, and the number of laws surrounding taxes, investments, and fees don’t help matters much. If you’ve taken out a 401k loan and plan on switching jobs, you should make every effort to pay this loan back as quickly as humanly possible.
However, if you’re unable to do so, there are options you can take to make those tax penalties sting just a bit less. Whenever in doubt, turn to a trusted financial advisor and try to stay as up-to-date as possible in your own financial literacy.
BEFORE YOU GO: Don’t forget to check out my latest article – ‘Exploring Social Trading: Community, Profit, and Collaboration’. I surveyed 1500+ traders to identify the impact social trading can have on your trading performance, and shared all my findings in this article. No matter where you are in your trading journey today, I am confident that you will find this article helpful!
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