401K Loan Default

It's big.

The defaulted loan amount will be treated as ordinary taxable income and will be taxed at whatever your ordinary rates are. If 25% then 25% or more if you move up a bracket.

If you are under age 59 1/2 add an additional 10% early distribution tax.

And some states and local jurisdictions may tax the IRA distribution.

2013 I will be moved to a new company and even though both companies used Fidelity I have been told that I must pay off loan within 60 days or default. As of January 2012 my balance will be 27,000.00. Currently I am in the 25% tax backet. I know I will be taking a big hit but was wondering how big in general so I can start to prepare.

----------- It's big.

---------- If it doesn't push you up a bracket it will cost you $6750. If it pushes you up the 28% bracket it will cost you an additional 3% of the amount that exceeds the top of the 25% bracket

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If there's any way to borrow $27K, any way at all, I'd do it, transfer the 401(k) over, then borrow the $27K to kill the new loan.

This is the risk of the 401(k) loan. A risk that congress needs to address, by allowing people to keep making payments, or even suspend payments while between jobs, then simply transfer the 401(k) along with the loan to the new employer.

What if there never is a new employer?

I don't understand your reasoning here (let alone whether 401k custodians could handle this -- what a nightmare). Why not have Congress address the "risk of the 401(k) loan" by simply eliminating it?

This only works if the new employer allows 401(k) loans.

I'll agree with this, Mark. If having custodians deal with open accounts is an issue, I still think a provision to transfer the loan is reasonable for job changers. A worker buys a house, uses $50K loan from 401(k), has a better offer a year later, but doesn't have the liquidity to payoff the loan. A $20K hit in taxes and major hit to his retirement account. The opposite of a 'signing bonus.' My views on the 401(k) loan have changed over the years, and I'm now leaning toward "too risky even in good times."

to Bill Brown - If there were no new job, at least the worker might have the option of taking the income hit in the lower (zero?) income year. The OP here offered a good scenario, a job change. My comment is as I replied to Mark, pretty ironic the change will cost him dearly, tax and penalty, on an otherwise positive transition.

I'm flexible, if congress makes no changes, I'm now anti-loan in most circumstances.

...

I wasn't suggesting "no good job." My point is that employers are NOT required to allow loans to be taken from their 401(k) plans. If the new employer doesn't allow loans, then the income spike occurs in a regular, not low income, year.

Anyone who thinks Congress is going to change this rule, raise your hand. ... ... OK, I see two hands on the keyboard and zero hands in the air.

I've been anti-401(k) loans for as long as I've understood the tax implications. You would be surprised how many denizens of the former MSN boards thought I was wrong, especially (and ironically) when the economy was shedding 500,000+ jobs a month.

Ha ha...odd coincidence. I rarely tune in to Suze Orman on TV, but just saw an episode a few nights ago where she reiterated her vehement anti-401k loan stance. Her reasoning (double-taxation of principal payments on the loan, once going in and once coming out) was a little faulty (it ignores the tax-free distribution of the original loan amount), but her conclusion was solid.

Money you need in the next five years shouldn't be in a volatile investment or pre-tax account, otherwise you are misleading yourself as to the true amount of your savings. If someone wants to gamble and use their pre-tax 401k as an emergency fund (i.e. money needed in less than five years), then they should accept the risk of paying tax+penalty on the emergency withdrawal.

-Mark B.

Each situation is unique. Borrowing for an emergency means one isn't saving enough in their actual emergency account. I was thinking of the

10 year loan to use some funds as a down payment. Given the choice between not getting one's full 401(k) match from diverting money to savings, and taking the loan, I'd have suggested the loan. Now, I'd recommend that if one can't save to the match (5-6% typical) and still save that downpayment, they are not budgeting properly. It's too easy for one to believe their own position is far more secure than it really is. Your note above is right on target. I am officially a convert.