401(k)s

Will a 401(k) Loan Default Hurt My Credit?

Find out what happens if you default on a loan to yourself.

Q: I took out a loan against my 401(k) retirement account. Now I've been laid off. If I default on the loan, will it affect my credit score? I know that I will pay a 10% penalty and will have to declare the loan as income on my tax return.

Employers do not report defaults to the credit bureaus, so your credit score will not be affected. Instead, the loan becomes a tax liability. "It is deemed a distribution from the plan," explains David Wray, president of the Profit Sharing/401(k) Council of America, which represents companies that sponsor profit-sharing plans.

If you leave your job for any reason, your 401(k) loan is usually due in full within 60 days. If you can't repay it, you will receive a Form 1099 (and the IRS will receive a copy) that shows the amount on which you owe taxes. You have until April 15 of the following year to pay the tax. Employees 55 and older who take a 401(k) distribution because they have lost their job do not owe the 10% early-withdrawal penalty.

Wray cautions workers who are considering taking a 401(k) loan to be aware that should they default, 40% or more of the money could go to the government, assuming 25% in federal taxes and 5% in state taxes, plus the 10% early-withdrawal penalty. So you might net only $4,500 from a typical $7,500 loan.

Most Popular

Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021
How to Calculate the Break-Even Age for Taking Social Security
social security

How to Calculate the Break-Even Age for Taking Social Security

When it comes to maximizing your Social Security benefits, there are many elements to consider. One factor that can be especially enlightening is your…
August 30, 2021
Spend Without Worry in Retirement
Financial Planning

Spend Without Worry in Retirement

Fears of running out of money prevent many retirees from tapping the nest egg they’ve worked a lifetime to save. With these strategies, you can genera…
August 30, 2021

Recommended

12 Questions Retirees Often Get Wrong About Taxes in Retirement
retirement

12 Questions Retirees Often Get Wrong About Taxes in Retirement

You worked hard to build your retirement nest egg. But do you know how to minimize taxes on your savings?
August 27, 2021
How to Find a Lost Retirement Account
Financial Planning

How to Find a Lost Retirement Account

A national database to find forgotten 401(k)s and pensions could be on the way, but savers should take action now to locate any missing retirement acc…
August 27, 2021
To Make the Most of Your 401(k), Hire an Adviser Right Now
401(k)s

To Make the Most of Your 401(k), Hire an Adviser Right Now

Your 401(k) may be your biggest retirement asset, yet chances are you’re not really managing it. More companies are letting their employees hire profe…
August 25, 2021
3 Great Reasons to Try After-Tax 401(k) Contributions
401(k)s

3 Great Reasons to Try After-Tax 401(k) Contributions

They won’t save you money on your taxes this year, like the more well-known (and popular) pretax 401(k) contributions do, but three types of people co…
August 9, 2021