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-- Posted: July 18, 2000

Dorothy Rosen -- The Dollar Diva Ask the Dollar Diva

When you owe on a 401(k) loan and can't pay it back ...

Dear Dollar Diva,
I borrowed $8,000 from my 401(k) plan in January, and was paying myself back through weekly payroll deductions at 9 percent interest. I have recently left the company, and they want me to pay the entire balance back in one lump sum.

Do I have any other options? I can't afford to pay it all back. Why can't I still make weekly payments?


If your plan does not allow you to make weekly payments, then you can't. If you don't believe them, have them show it to you in writing. Most plans don't allow payments on 401(k) loans after the employee has left the company, and if your plan doesn't, you're stuck between a rock and a hard place. You either have to:

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  • Pay the balance in full or
  • Treat the loan as a withdrawal and pay income tax on it, as well as the 10 percent early withdrawal penalty if you're less than 55 years old.

If you treat the loan as a withdrawal be prepared to go scratching for cash at tax-time. Adding insult to injury, withdrawals from retirement plans often push taxpayers into a higher tax bracket. Assuming you still owe $7,500, here are the taxes and penalties that you'll have to pay if you're in the 15 percent or 28 percent tax brackets:

 

15 % Tax Bracket

28% Tax Bracket

Federal Income Tax

$ 1,125

$ 2,100

10% Penalty

750

750

Total Federal Tax and Penalty

$ 1,875

$ 2,850

.

The taxes and penalties are a small part of your loss. The real tragedy is the loss in tax-deferred, compound earnings over the years. Use our "Should I borrow from my 401(k) plan" calculator to see what your ultimate loss is when you borrow from your 401(k) plan. And if you can't pay it back this time, resolve never to touch your retirement savings again.

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