loan from 401K

[oceanlovin'ea]

This client borrowed money from his 401K last year to purchase a condo in Utah. They has since moved to Utah since all their children are in that side of U.S. He has been making the payments on his loan.
His question is If he stops making the payments on the loan, will the borrowed money become a distribution and in what year would it be taxable - last year when he borrowed the money or this year when he stopped making the payments?

He is also considering taking the rest of his 401K money out which I think is around $100,000. He 61 so there would not be a penalty but it will be added to their income which is already over $100,000. Between their salaries, the loan proceeds and the distribution, he will be paying way too much in taxes.

But my work with them will all be done by email and fax this year. So I may have a hard time convincing them of this.

Hope someone knows the answer to his question or where I can find the answer.

Thanks

Linda

[S T]

401K borrow

From what I understand and what I have experienced in the past on 401K loans, the loan becomes due and payable and a taxable distribution made when the client ceases to make the loans payments or is terminated from employment.

It occurs in the tax year that the above event happens.

The balance of the 401K above the loan amount, would be fully taxable in the year of distribution, but it would seem that the t/p would have a rollover provision for that amount.

Example: $200,000 value in 401K, $100,000 loan value, cease payments or separation from employment, $100,000K loan amount would be a distribution on form 1099R fully taxable in year of separation of service or loan payments cease,

$100,000 balance left in 401K account, could be rolled over to a rollover IRA (non taxable) minimizing tax consequence for current taxable year and could be distributed in another year or over a period of years as needed, and then would become taxable in the year of those distributions.

Sandy

[New York Enrolled Agent]

This is Q&A 10 from Reg. §1.72(p)-1

Q-10. If a participant fails to make the installment payments required under the terms of a loan that satisfied the requirements of Q&A-3 of this section when made, when does a deemed distribution occur and what is the amount of the deemed distribution?

A-10. (a) Timing of deemed distribution. Failure to make any installment payment when due in accordance with the terms of the loan violates section 72(p)(2)(C) and, accordingly, results in a deemed distribution at the time of such failure. However, the plan administrator may allow a cure period and section 72(p)(2)(C) will not be considered to have been violated if the installment payment is made not later than the end of the cure period, which period cannot continue beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.

(b) Amount of deemed distribution. If a loan satisfies Q&A-3 of this section when made, but there is a failure to pay the installment payments required under the terms of the loan (taking into account any cure period allowed under paragraph (a) of this Q&A-10), then the amount of the deemed distribution equals the entire outstanding balance of the loan (including accrued interest) at the time of such failure.

(c) Example. The following example illustrates the rules in paragraphs (a) and (b) of this Q&A-10 and is based upon the assumptions described in the introductory text of this section:

Example. (i) On August 1, 2002, a participant has a nonforfeitable account balance of $45,000 and borrows $20,000 from a plan to be repaid over 5 years in level monthly installments due at the end of each month. After making all monthly payments due through July 31, 2003, the participant fails to make the payment due on August 31, 2003 or any other monthly payments due thereafter. The plan administrator allows a three-month cure period.

(ii) As a result of the failure to satisfy the requirement that the loan be repaid in level installments pursuant to section 72(p)(2)(C), the participant has a deemed distribution on November 30, 2003, which is the last day of the three-month cure period for the August 31, 2003 installment. The amount of the deemed distribution is $17,157, which is the outstanding balance on the loan at November 30, 2003. Alternatively, if the plan administrator had allowed a cure period through the end of the next calendar quarter, there would be a deemed distribution on December 31, 2003 equal to $17,282, which is the outstanding balance of the loan at December 31, 2003.

[oceanlovin'ea]

Nyea

Thank you so much. That is exactly what I needed. I will email my client and tell him the jolly good news.

I hope he will reconsider leaving the rest in his 401K account.

Linda