Most 401(k) retirement plans allow you to take out loans, which usually must be repaid within five years. If you change employers, however, the clock speeds up and a loan you've taken out from your 401(k) may be due in full very quickly. Even worse, you may face serious tax consequences if you can't repay it.
Determine Payback Time
If you leave an employer while you have an outstanding 401(k) loan, it's probably best to assume it will be due right away rather than later on. In fact, the loan typically becomes payable immediately and in full, whether you leave on your own or are laid off or fired. Depending on the employer you might get as long as 90 days to repay. Your employer may allow you to set up a payment plan, but don't count on it. That can generate a lot of hassle to help someone who doesn't work there anymore.
Consider the Tax Man
It's not the end of the world if you don't repay your 401(k) loan in full when you leave your current job for a new one. However, it's going to cost you. The unpaid balance is treated as a withdrawal of money from your 401(k) account. Also known as distributions, those withdrawals are considered taxable income, which means you'll have to pay income tax on the balance.
You'll also have to pay a 10 percent penalty on top of that if you're younger than 59 years and 6 months old. Say you're in a 20 percent tax bracket and you have an unpaid balance of $10,000. You'll owe $2,000 in income taxes and a penalty of $1,000.
Speed Up the Process
If you're thinking about a job switch and you have a 401(k) loan, you could start increasing your loan payments. Typically, you repay 401(k) loans with money taken directly out of your paycheck. Ask the payroll department to start withholding more from each check. (You don't have to tell anyone you're planning to leave; it's not unusual for people to want to retire loans as early as possible). That might whittle down or even eliminate your loan obligation before you punch out for the last time, depending on how much you owe and how much lag time you have.
Exploring Alternative Options
One option for repaying a 401(k) loan quickly is taking out a home equity loan or personal loan. While you still have to pay back the new loan, you'll have more time to do so and you won't take a tax hit. Another possibility: Roll the balance of your 401(k) into your new employer's retirement plan, get a loan from that plan, and then use it to pay off the first loan. However, that assumes you would immediately qualify for a loan as a new employee.
- 401(k) Help Center: 401k Plan Loans - An Overview
- Intuit TurboTax: What Happens if I Have a 401(k) Loan but Later Lose or Quit my Job?
- WalletHub: Can I Rollover 401k to IRA With Loan Against It?
- IRS. "Retirement Topics - Plan Loans." Accessed Nov. 2, 2020.
- FINRA. "401(k) Loans, Hardship Withdrawals and Other Important Considerations." Accessed Nov. 2, 2020.
- IRS. "Relief for Taxpayers Affected by COVID-19 Who Take Distributions or Loans From Retirement Plans." Accessed Nov. 2, 2020.
- Charles Schwab. "The Charles Schwab Guide to Finances After Fifty: Does It Make Sense to Borrow From My 401(k) if I Need Cash?" Accessed Nov. 2, 2020.
- Maxwell Locke & Ritter. "Options for Your 401(K) Plan at a Former Employer." Accessed Nov. 2, 2020.
- IRS. "Retirement Plans FAQs Regarding Loans." Accessed Nov. 2, 2020.
- The Pension Research Council at the Wharton School. "Financial Literacy: Implications for Retirement Security and the Financial Marketplace: Chapter 4: Financial Literacy and 401(k) Loans," Page 71. Accessed Nov. 2, 2020.
- IRS. "Retirement Topics - Bankruptcy of Employer." Accessed Nov. 2, 2020.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.