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401(k) BORROWING CAN BE COSTLY

July 31, 2008

If you borrow from your 401(k) plan and then lose your job, you can find yourself facing an ugly tax situation. If you don't somehow repay the loan and are under age 59 1/2, your loan will be considered an early distribution and you'll get smacked with income tax on the loan and a 10% early withdrawal penalty. The Benefits Blog elaborates (my emphasis):

If you want to read a good case in point that illustrates how things can go awry when it comes to a 401(k) plan loan, read the recent Tax Court case of Tilley v. Commissioner. The participant in that case had borrowed from her 401(k) account to purchase a home, but when she was terminated, couldn't pay the loan off. Even though the participant received a Form 1099R indicating that the unpaid loan balance was taxable, the participant failed to pay any additional tax on the distribution. The IRS ended up assessing tax on the loan balance, a 10% early distribution penalty as well as a 20% negligence penalty. After trying to allege that a call center representative for the provider had indicated that the distribution was not taxable, the Tax Court stated that it was not reasonable for the taxpayer "to rely on a. . . call-center representative for tax advice."

The whole point of a 401(k) is to help you save. Borrowing from your 401(k) badly misses the point.

The Benefits Blog has more links to stories on 401(k) borrowing.

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