Q: My son wanted to refinance his house, but it was underwater. So, he took a loan against his 401(k) to pay off the second loan on the property. He had started to pay back the loan by automatic withdrawal from his weekly paycheck, but all of a sudden was permanently laid off from his job.
He called the company that manages his company’s 401(k) plan and was told he has 60 days to pay back the loan in full, cash out the plan, or transfer his 401(k) to a new IRA. Also, the company he had worked for is fighting paying his unemployment benefits. So that income is on hold until the hearing is settled.
The good news is he will start a new job with the federal government at the end of this month, but we don’t know what he can do about his 401(k) loan. Do you have any suggestions?
A: If you don’t pay back a 401(k) loan within 60 days, the IRS will treat it as a distribution from the 401(k) and your husband will owe taxes and perhaps penalties on the cash.
(This is why I never recommend borrowing from a 401(k) – you just never know when you’re going to lose or change your job these days.)
Your son has two choices: Find a way to pay back his 401(k) account in full within 60 days, or take the loan as a distribution.
Whichever he decides, your son should roll the rest of the account over to an IRA. That will give him the opportunity to invest the money where he deems best and avoid paying taxes on that money until he really needs it when he retires.