Part 2: Expert Answers for Your 401(k) Questions About Repaying a Plan Loan

Q: I am really afraid that I'm going to lose my job as a result of this recession. If that happens, I'll have to repay a $25,000 loan from my 401(k) right away. What are my options?

A: If you cannot repay the 401(k) loan upon termination of employment, the outstanding balance will be treated as a distribution of 401(k) funds to you and will be taxed as ordinary income. If you are younger than the age of 59½, you'll have to pay an additional 10% excise tax penalty for making an early withdrawal from retirement funds. (There is an exception to the 10% withdrawal penalty if you are 55 or older in the year you lose employment.) That's a big hit, especially if you're jobless.

One option is to talk to a loan officer at your credit union about the possibility of getting a loan you can use to pay off your 401(k) loan now. You'd still have to make payments on the credit union loan, but you'd avoid the tax penalty. Your employer's 401(k) plan provider should offer a toll-free telephone consultation or an online calculator so you can get more information about the differences between a 401(k) loan and regular consumer loans.

In the future, remember that you're usually better off borrowing money for big-ticket items from your credit union instead of from your 401(k). That preserves your retirement savings without putting you at more risk if your job status changes.

Readers should seek independent professional advice before making investment decisions.

Published September 28, 2009

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