401(k) Loans Liberalized in Latest Tax Law

Among the problems with loans from 401(k) accounts are that you traditionally had only 60 days to repay them after leaving an employer. Fail to repay, and you included the loan amount in gross income and paid a 10% penalty if you were under age 59 1/2. The latest tax law liberalized the terms for those leaving an employer.

Historically, 90% of borrowers have repaid 401(k) loans, according to a Pension Research Council study. But others fell into a trap: If you left a job, you typically had just 60 days to repay, or it would count as a distribution, subject to income taxes and a 10% early withdrawal penalty. Congress threw in a fix in the new tax law to help stem these defaults.

“Employers are concerned about 401(k) leakage,” says Joseph Adams, an employee benefits lawyer at Winston & Strawn in Chicago. “They’ll tell people leaving they have this new tool to repay their loan. It’s a nice change.”

The new law, which applies to loans taken after Jan. 1, 2018, gives workers a little more time. When you leave a job, you have until October of the following year (the due date of your tax return on extension) to put the money back into your 401(k) or an IRA or a 401(k) at a new employer. By paying the loan back, you avoid the tax hit, and preserve your retirement funds.