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Reviewing Participant Loans

Published by Kim Moore on Jun 22, 2020 6:00:00 AM

Are you thinking about taking a loan from your 401(k)? Participant loans are a nice feature that’s offered by many 401(k) Plans as an option if an emergency were to come up a Plan participant may need funds for just a short period of time. Interest rates are generally low and there’s less paperwork involved than with a traditional bank or private loan.

Also, many employers think that since the money belongs to the participants, access should be unrestricted. However, employers should make sure that participants are aware that if the full amount of the loan is not repaid, any remaining amount remaining unpaid will be fully taxable to the employee upon default.401k loan man_sitting_on_laptop_18929

Most of the funds used for loans are originally put into the participant account as pre-tax money (federal taxes were not withheld from the payroll amounts prior to the addition of the funds to the 401(k) account). For this reason, the IRS requires loan amounts from pre-tax accounts to become taxable if the employee leaves the company or is terminated from service.

Without repayment of the full amount outstanding, the remainder becomes taxable income to the employee and the Plan service provider will issue a 1099R to the employee for the year in which the loan payments cease. This amount will need to be reported as income on the tax return for the employee for that tax year and the resulting tax will need to be paid. If this is not anticipated, an employee may have a large tax amount due that they will be unable to pay. Penalties and interest will then be assessed by the IRS upon non-payment. 

It’s highly recommended that employers counsel employees when a 401(k) loan is requested. In recent studies, it’s indicated that 70% of employees have stated if they lost their job, they would be unable to repay the loan amounts. The younger the employee is, the more worried they are about repaying the loan amount. Communication of the loan requirements and the consequences if the loan is not repaid may help an employee avoid a serious tax problem later.

Retirement plans can be very complex. As an innovative firm Summit CPA specializes in 401(k) audits. We have the ability to offer assistance entirely off-site with little or no distraction to your daily office routine.  We also offer flat-fee pricing so there are no surprises on your bill when the job is complete. For assistance contact our office at (866) 497-9761 to schedule an appointment.

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