401K loan and the age 55 rule
I have a client that has a thrift savings plan 401(k) through the federal government. He took a loan out several years ago and it currently has a remaining balance of $33,000. He has recently decided that he will retire in January 2015, which will be immediately after turning age 55.
He inquired if he would have a 10% penalty on the 401(k) loan that will be a deemed distribution if not paid off before he retires.
I have researched and have been unable to find an answer on the IRS website whether that would be subject to a 10% penalty or not.
The loan was taken out prior to age 55 (a couple of years ago – lets say at the client’s age 53), but will not be considered a distribution until after he retires which is when it will be a taxable distribution.
Will the IRS look at the time of distribution being the date of the original loan, or will they deem it being the date that he separated from service which will be in the year that he turns age 55 and thus not subject to the 10% penalty?
Permalink Submitted by Alan - IRA critic on Tue, 2014-11-18 03:48
This is a question that I have also been unable to come up with any direct guidance. If the loan was originally invalid, then the distribution should be considered to have occurred in that year and the 1099R would be coded 1. On the other hand, if the loan was not in default at the time of separation, failure to repay as required would result in an offset distribution, not a deemed distribution. In that case, the age 55 separation exception should waive the penalty. The gray area is a deemed distribution processed prior to separation for failure to make loan payments, and the age 55 exception would not apply to that, so the 1099R should be coded for a deemed distribution and code 1 for an early distribution. Due to lack of specific guidance, we cannot be sure that is how each plan would handle the 1099R.