What happens to my 401(k) loan now that I left my job?

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Q. I took a home loan from a 401(k) a couple years ago. Since it was for a qualified reason, there was no early withdrawal penalty. I recently left my employer so there’s an outstanding loan on the 401(k) that I have to settle up in 60 days otherwise it would be considered a distribution and subject to taxes and penalties because I’m 40 years old. Can I instead roll the 401(k) into an IRA? Could I qualify for a CARES Act withdrawal?
— Still working

A. There’s a lot to clear up here.

You said you took a loan, so there would be no penalty on a 401(k) loan itself.

But if you leave your job, you would probably have to pay the funds back within 60 days otherwise it would be considered a distribution and subject to taxes.

If you wanted to roll over the rest of the account into an IRA, you can do that, but there’s still the issue of the outstanding loan.

If you have the funds to pay back the loan, you could pay it back whether you roll over the funds or not. In that case, there would be no distribution considered.

The CARES Act has nothing to do with a transaction that happened before this year, said Jerry Lynch, a certified financial planner with JFL Total Wealth Management in Boonton.

“The CARES Act does allows people to take out distributions from their 401(k) and pay it back over three years, or they can pay the tax at any point during the three years — but you need to be under financial duress due to COVID and it does not sound like that is the case as you voluntarily left work,” Lynch said. “Also, the 401(k) plan would need to be amended to include this provision for this to happen, and it may not have.”

Based on the timing of what you’ve described, it seems you would owe a 10% penalty and ordinary income taxes on outstanding balance on the loan, Lynch said.

You should speak to a tax preparer who can examine the details of your situation so you can review all your options.

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This story was originally published on Nov. 19, 2020.

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