When 401(k) Loans are Considered to be in Default

When 401(k) Loans are Considered to be in Default

By Wiss (497 words)
Posted in Employee Benefit Plan Audits on November 08, 2016

There are (11) comments.

By Laura Zindel

Taking out a 401(k) loan can seem like a relatively simple way to borrow money. It is a very common practice, but many employees who borrow from their plans aren’t prepared for the financial consequences of doing so if a loan ends up in default.

The most common reason for defaulting on a 401(k) loan is the loss of a job. If the employee loses his or her job, the plan document rule requires that any outstanding loan balance must be repaid within a certain timeframe, based on when the default occurred. Most plans require employees to repay their loans through payroll deductions, and employees become so accustomed to this automated process that they don’t even realize their loan is no longer being repaid after termination — until it’s too late. 

Participants who are still employed can also default on loans. If they elect to forgo the automatic payroll deductions and pay via a check, or ask their employer to halt the automatic payroll deductions, they are still at risk for a loan default if payments to their loans are not made timely. 

When is a 401(k) loan considered to be in default?

As with any loan, 401(k) loans default when payments aren’t made on time. Each plan can specify its time limits, but many plans offer cure periods, or grace periods, that extend until the last day of a calendar quarter following the calendar quarter when a missed payment was due. For example, if you miss a loan payment that was due July 1, you would have until Dec. 31 to make a payment before your loan goes into default.

What happens when a 401(k) loan defaults?

Plans allow loans to be the lesser of 50 percent of a participant’s 401(k) balance, or $50,000, so that, if they default, the remaining account balance has sufficient assets to cover the loss. Once a loan defaults, this action is treated as a 401(k) withdrawal, which is subject to taxation. Accordingly, the plan administrator will issue a 1099 to the participant showing the distribution amount and what taxes are owed. In addition, if you’re younger than 55, you’re also subject to a 10 percent early withdrawal penalty.

Although 401(k) loan defaults don’t impact your credit score or carry long-term consequences, the short-term costs can be daunting.

Employees don’t often consider this worst-case scenario when taking out a 401(k) loan. Instead, they assume they have five years to pay it back through payroll deductions. So before moving ahead with a loan, first consider what your long-term plans are for your career and what would happen if you stopped receiving paychecks and ended up in default.

Laura Zindel is an Audit Manager with over 6 years of public accounting experience. She has provided audit, accounting, tax and business advisory services to privately-held businesses in industries such as manufacturing, wholesaling/distributing, and professional service firms. Laura is involved with the Employee Benefit Plan Group at the firm and audits several Defined Contribution and Defined Benefit Plans.

Comments (11)

Tom posted on: September 27, 2017

I took out a loan from my 401K plan back in 2013. Without going into all the details my payroll deducted payments were not made timely. I was told by my company's plan administrator the mistake was the payments were paid every pay period instead of every 15 days causing me to slowly go into default, AXA Equitable was the "sponsor" with our office manager in charge of the day to day responsibilities. I was issued a 1099 and penalized for this default. My question's are....

1. Was my plan mismanaged by either AXA or my plan administrator? And if so...
2. Was there a breach of fiduciary responsibility?
3. Do I have any recourse for any potential mismanagement not caused by me?

I felt confident my payments were being made on time, I saw them on my pay stub.

John posted on: February 23, 2018

I had taken out a 401k loan for a down payment on my current property. The loan almost went into default but I was able to bring the loan current and reinstate the loan. I went onto the fidelity investment website to find out that they reported the loan as a default. When I called the Fidelity Investment customer service center they initiated an investigation. After 4 weeks fidelity investments would not reinstate the loan. The default was an error from the customer service end but the default would stand although it was admitted that they were in the wrong.
Iam going to initiate a formal complaint to Fidelity Investments. Wondering if you have any advice on this. I plan on going up the food chain. Someone will eventually listen. I also thought about complaining to the IRS about this.

Priscilla kinard posted on: February 26, 2018

I was in a car accident that caused me to be out of work for a year and I had a 401k loan at the time for the fist six months the money came out of my paycheck as usually and then I went in to long term which was another six months at that time I was being payed by a third party so the loan payment was no longer coming out of my paycheck which cause me to default on my loan. My 401k provider said they had sent me a correspondent but I didn't get it and the next letter they sent was telling me that I was in default. What can I do

michael smith posted on: March 14, 2018

Are you looking for financial freedom? Are you in debt, you need a loan to start a new business? Do you need an investor or private investor? or you financially crash, do you need a credit that buys a car or a house? Have you reject your bank in getting finance? Do you want to improve your financial results? You need a loan to pay off your bills? no more looking, we welcome you for a way to get all kinds of loans at a very favorable interest rate of 2% for others. For more information, contact us now (michaelsmithloan16firm@gmail.com)call or text us on +19543629549

Subie posted on: March 25, 2018

I do not know if my recent experience will help but this is what I did. I took a loan and then left the company where I worked. I called the "sponsor" company (big name company - dont want to mention) and asked if I can make monthly payments and the agent says yes. After making a few payments the "sponsor" (big name co that I do not want to mention here) sent me a letter saying my loan is in default because 60 days have passed since I left the company. I filed a complaint mentioning that the agent misled me but was denied by customer service. I contacted the legal department of the "Sponsor" company and asked for the audio tape of my conversation (luckily I had the date and time of my original conversation) so that I can prove I was misled. Things went right from there and the sponsor admitted and paid me around $25,000. What you need to do is establish that either the office manager or the customer service rep made a mistake. That all I proved.

Mr oneil john posted on: April 9, 2018

Do you need a loan to pay your bills? Do you need personal or business loan? Need a loan for various other purposes? If yes, please contact us today at ( oneiljohn00@gmail.com ) for a loan. We offer the largest loan of $5,000.000.00. We offer loan @ 3% fixed interest rate for the duration of 1-20 years. We give two months grace period before monthly payment begins. So, if you are interested, In Getting A Loan Email Us oneiljohn00@gmail.com

mr Robert posted on: April 13, 2018

Good Day Dear Loan Seeker,

Do you need an urgent financial credit * Very fast and direct transfer
to your bank account
Repayment starts eight months after you get the money bank account *
Low interest rate of 2%
* Long-term repayment (1-30 years) Height * Flexible *then monthly payment
* How long will it be financed? After submitting the application
* You can expect a preliminary answer less than 24 hours funding in
72-96 hours after receiving the information they need yours.

If you are interested contact us via:

Mr oneil john posted on: April 15, 2018

We wish to give out loan to whom ever that is in need of a loan at interest rate of 3%, We give out loan from the minimum of 5,000.00 usd to the maximum 100 million dollars, pounds, euros, If interested, Contact us via email: oneiljohn00@gmail.com

Juliana Abel posted on: April 17, 2018

Am Juliana Abel, am here to testify on how i got my loan from Michael Welsh loan company successfully without any delay, after going through hell in the hands of those fake lenders who scammed me of my little hard earn money, But all the same am so happy right now God directed me to a reliable loan lender Michael Welsh where i finally got my desire loan amount, here is Michael Welsh company Email if you need loan too.(michaelwelshloanservice@gmail.com)

jack berry posted on: April 20, 2018

Hello All, I am jack berry by name, and am a very simple man. I work in a company called aseiamicrofanance, in this company we give out
company we give out loan with a very low interest rate of 3%. We give out all kinds of
loan in which you need. We need only serious applicants, so don't come
here and play with our business. Feel free to contact us today through
our email address Below: Email: aseiamicrofanance@gmail.com

Elijah Church posted on: April 24, 2018

Elijah Capitals and Mortgages Limited® has very helpful staff who have helped me out of a financial crisis. They take the time to carefully explain the procedures in obtaining the loan and go through solutions to resolve any financial issues you might have. Special mention to the stall namely Ms Tracy and Mr Steven who i think are very meticulous in their work and deserve special mention. Kudos and keep up the good work. People might come in with worries and problems but trying them out definitely helped solve my problems. I hope others will be able to experience what i had, and you can reach them at elijahcapitals@gmail.com

Leave a comment

* denotes required field
* Email will not be published
* Used to help prevent spam

Text only, html will be removed from comment