Deemed 401K Loan

[401kchallenged]

this is a really long story - but to just cut to the chase, I had a loan deem on my 401K account about 6 years ago due to my employers' error to make the necessary payments from my paycheck.   I had tried every which way to have them fix this and was told there was no way to fix it - I paid the penalty and taxes on it back then - not realizing, of course, that this would stay on  my account FOREVER (until I retired, etc.) and would limit any other loans I could take.  I am now wanting to do a early partial distribution in the amount of $50,000 (I know about the penalty and taxes since I am not 59 1/2 yet)  - my question is - will the deemed loan have to be paid out of that early distribution that I take or since there will still be plenty in the account to cover the loan - can that be done when I turn 59 1/2 and get a full distribution?  Hope all of that makes sense.  thanks in advance!

[Bri]

I would want to ask, how are you eligible for a $50,000 distribution from the plan at an age less than 59½?  Is this other-source money such as match or profit sharing where the plan permits the earlier withdrawal?

If you are eligible indeed under such provisions, then I'd double-check that the loan balance really did originate from 401(k) money (as opposed to match / PS).  If so, then the fact that you have a distributable event for whatever source is going to fund the 50,000, leads rise to the potential to discharge the defaulted loan note off your balance.

However, if the loan money was 401(k) money specifically, the Regulations won't let the plan to offer you an out before age 59½, so the loan would stay.

If your plan does let you take the 50,000, then you certainly could remit the loan balance still due (with interest) back to the plan.  The only benefit, really (since you've already had the taxable income back six years ago), would be the ability to clear your loan slate and start over with new ones.  Otherwise you're just creating a taxable basis in your account.

[QDROphile]

Repaying the loan does more than create taxable basis.  It is an investment that provides tax deferral on the earnings.  However, that investment decision is not a no-brainer.  One must consider the restrictions on distribution and the ordinary income rate of taxation vs. capital gains (depending on the actual investment choice).

[Patricia Neal Jensen]

I agree with Bri.... How are you taking a pre-59.5 distribution?  What plan provision?  Legal theory?

PNJ