Should You Report A 401(K) Loan On Your W-2?

A 401(k) loan is a retirement plan feature that allows employees to borrow from their retirement account balance for a short-term purpose, such as an emergency. There are two types of 401(k) loans: a general-purpose loan and a residential loan. While a 401(k) loan can be a great option for employees in need of quick cash, it is important to understand the repayment rules and the implications on your W-2 form. So, does a 401(k) loan show on your W-2 form?

401(k) loan types

A 401(k) loan is not considered income because you are borrowing your own money. You are simply taking a temporary distribution from your retirement savings and are obligated to repay it with interest. That said, 401(k) loans can usually be borrowed up to $50,000 or 50% of your account balance, whichever is less. An exception to this limit is if 50% of the vested account balance is less than $10,000; in this case, the participant may borrow up to $10,000.

Loans and withdrawals from workplace savings plans (such as 401(k)s or 403(b)s) are different ways to take money out of your plan. A loan lets you borrow money from your retirement savings and pay it back to yourself over time, with interest—the loan payments and interest go back into your account. A withdrawal, on the other hand, permanently removes money from your retirement savings for your immediate use, but you'll have to pay extra taxes and possible penalties.

The impact of a loan that has to be paid back over many years can be significant. For example, during the life of the loan, you will be missing out on the potential growth of those funds. In addition, some 401(k) plans have provisions prohibiting contributions to your account until you repay the loan balance. If your employer matches contributions, you will also miss out on that match.

If you take a plan loan and then lose your job, you will have to repay the loan in full. If you don't, the full unpaid loan balance will be considered a taxable distribution, and you could also face a 10% federal tax penalty on the unpaid balance if you are under age 59½.

Borrowing limits

It's important to note that the plan may not always allow for loans, and even if it does, there may be a limit to the number of outstanding loans permitted. Additionally, the loan must be repaid within five years, and the interest paid on the loan goes back into the borrower's retirement plan account.

In certain circumstances, such as natural disasters, the maximum amount that can be borrowed may be increased. For example, in the case of Hurricanes Harvey, Irma, and Maria, the maximum amount was increased to the lesser of $100,000 or 100% of the participant's account balance.

If an individual with a 401(k) loan leaves their job, they may be required to repay the full outstanding balance of the loan. If they are unable to repay, the loan is considered defaulted, and they will owe taxes and a 10% penalty on the outstanding balance if they are under 59 and a half years old.

It's worth noting that 401(k) loans are not reported on a federal income tax return, and they do not impact an individual's credit score in the event of a default.

Loan requirements

A 401(k) loan will generally not be reported on a W-2 form because it is not considered income; you are simply borrowing your own money. However, if you default on the loan, it may be reported in Box 1 of the W-2 form, which is used to report wages, salaries, and other forms of taxable income.

Now, here are some key loan requirements for a 401(k) loan:

• Retirement plans, including 401(k) plans, may offer loans to participants, but a plan sponsor is not required to include loan provisions.
• To determine if a plan offers loans, check with the plan sponsor or the Summary Plan Description.
• The maximum amount you can borrow is typically 50% of your vested account balance or $50,000, whichever is less.
• An exception to this limit is if 50% of the vested account balance is less than $10,000; in this case, you may borrow up to $10,000.
• You will have to pay back the borrowed money, plus interest, within five years of taking the loan, with payments made at least quarterly.
• Some plans may require consent from your spouse or domestic partner for loans over a certain amount (e.g., $5,000).
• If you leave your job, you may have to repay the loan in full, and if you cannot repay for any reason, it is considered defaulted.
• In the case of a default, you will owe taxes and a 10% penalty on the outstanding balance if you are under 59 1/2 years old.
• Loan repayments are typically made through payroll deductions.
• Unlike 401(k) withdrawals, you don't have to pay taxes and penalties when you take out a 401(k) loan, and the interest goes back into your retirement plan account.
• A 401(k) loan can be beneficial for paying off high-interest debt, such as credit cards, or funding major home improvement projects.
• It is important to continue making regular contributions to your 401(k) while repaying the loan to keep your retirement strategy on track.

Repayment rules

A 401(k) loan is not reported on your income tax return and does not show on a W-2 form. However, if you default on the loan, it becomes a distribution and you will receive a Form 1099-R, which will be reported on a tax return.

Now, let's discuss the repayment rules for a 401(k) loan:

When taking a loan from your 401(k), it's important to understand the repayment rules to avoid any negative consequences. Here are the key guidelines to keep in mind:

• Repayment Period: In most cases, you must repay the borrowed money within five years. However, if you are using the loan to purchase a primary residence, you may have a longer repayment period.
• Payment Frequency: Payments must be made at least quarterly, and they should include both principal and interest. These payments are not considered plan contributions.
• Maximum Loan Amount: The maximum loan amount is typically the lesser of 50% of your vested account balance or $50,000. For example, if your vested account balance is $40,000, the maximum loan amount would be $20,000.
• Spouse's Consent: Some plans may require written consent from your spouse or domestic partner for loans exceeding a certain amount, such as $5,000.
• Military Service and Leave of Absence: If you are in the military, your employer may suspend loan repayments during your period of active duty, and the loan repayment period can be extended accordingly. Similarly, during a leave of absence, your employer may suspend repayments for up to a year if your salary is reduced and you cannot afford the payments.
• Employment Termination: If you leave your job, your employer may require you to repay the full outstanding balance of the loan. Failure to do so can result in the loan being considered defaulted, leading to taxes and a 10% penalty on the outstanding balance if you are under 59½ years old.
• Default and Deemed Distributions: If you miss payments or do not follow the required repayment schedule, your loan may be considered a "deemed distribution." This means the remaining balance is treated as a distribution subject to income tax and possibly the 10% early distribution tax.
• Correction of Mistakes: If there are issues with your loan, such as non-compliance with legal requirements or repayment schedules, you may be able to correct these problems using the Voluntary Correction Program.
• Regular Contributions: Even while repaying the loan, it is essential to continue making regular contributions to your 401(k) to keep your retirement savings on track.

Defaulting on a loan

A 401(k) loan default is treated as a taxable distribution from the plan of the entire outstanding balance of the loan (a "deemed distribution"). The plan's terms will specify how it handles a default, and a plan may provide that a loan does not become a "deemed distribution" until the end of the calendar quarter following the quarter in which the repayment was missed. For example, if quarterly payments were due on March 31, June 30, September 30, and December 31, and the participant made the March payment but missed the June payment, the loan would be in default at the end of June and treated as a distribution at the end of September.

If you default on a 401(k) loan, you will receive a Form 1099-R, which will be reported on a tax return. This means you will owe income tax (around 15% for most middle-class taxpayers) plus a penalty of 10% on the outstanding loan balance. This can add up to a significant amount, so it is generally advisable to repay the 401(k) loan if possible.

If you are unable to repay the loan, another option is to perform an indirect rollover to an IRA. This option is available until the tax-filing deadline, and you will need to place the loan amount in an IRA coded as an indirect rollover, not a contribution. While this option will result in taxes and penalties, it may be a better alternative than defaulting on the loan, especially if you are in a high-tax state or a high federal bracket.

Defaulting on a 401(k) loan can have significant financial consequences, so it is important to carefully consider your options and seek expert advice if you are facing this situation.

Frequently asked questions