Can a 401k loan be rolled over to another 401k?

If your 401(k) plan offers 401(k) loans, you can borrow against your retirement savings to pay for college, medical expenses, or other immediate needs. Usually, these loans have a repayment period of up to 5 years, but this period could be higher if you are using the 401(k) loan to buy a home. However, if you have an outstanding 401(k) loan when you quit your job, you have until the tax due date to pay off the loan.

Normally, you can’t rollover a 401(k) loan to another 401(k) when you leave your job for a new employer. You must pay off the outstanding loan balance, and if you default, the unpaid loan amount could be considered to be a deemed distribution or loan offset and you will owe income taxes and a potential penalty on the unpaid 401(k) loan. However, if the 401(k) plan is terminated or the former employer’s company is acquired by another company, you can rollover the 401(k) loan balance into another employer's 401(k).

Deemed Distribution vs. Loan Offset

If you leave your job and you have an outstanding 401(k) balance, the unpaid plan loan could trigger two types of distributions i.e. deemed distribution and plan loan offsets. A deemed distribution occurs when the 401(k) loan requirements are not met or upon default by the participant. Deemed distributions are not considered to be actual distributions from the retirement plan, and hence are not eligible for rollover to a new 401(k). However, the unpaid loan considered to be a deemed distribution creates a taxable event, and you will owe taxes in addition to an early withdrawal penalty if you are below 59 ½. Some 401(k) plans may allow participants to pay off the missed payments even after the unpaid 401(k) becomes a deemed distribution.

A plan offset occurs when the plan administrator reduces a participant’s 401(k) money to pay off an unpaid 401(k) loan. An offset is made when a 401(k) participant misses several loan payments, and the 401(k) loan is considered to be in default. It could also occur when a participant requests a distribution and they have an unpaid loan. The participant must be qualified to take a distribution for the unpaid loan to be considered a loan offset. The loan offset amount is subject to income taxes, and a 10% penalty tax if you are below 59 ½.

Can a loan offset be rolled over?

You can avoid paying taxes on the 401(k) loan offset amount by rolling it over to a 401(k) or other tax-qualified retirement plan. The funds for the rollover must come out-of-pocket so that the rollover amount can extinguish the loan liability. The participant can also use the 401(k) loan proceeds to pay the rollover. If the funds were already spent, you can take a bank loan to fund the rollover to the new employer’s 401(k).

Under the Tax Cuts and Jobs Act that became effective in January 2018, you must contribute an amount equivalent to the loan offset amount to the new 401(k) by the tax deadline. For example, if the loan offset occurred in 2020, you must contribute the amount of the loan offset by April 15, 2021. Before you rollover a loan offset, you must check with the plan administrator to confirm that the unpaid 401(k) loan will be treated as a loan offset and not a deemed distribution, since the latter cannot be rolled over.

Alternative options to 401(k) Rollover

If you have an unpaid 401(k) loan when you leave your employer for a new job, you can opt to pay off the loan quickly. Here are the alternative options to expedite the loan pay-off:

Make extra payments on a 401(k) loan

If your 401(k) plan allows extra payments on a 401(k) loan, you can increase the periodic payments or pay a lump sum to clear the loan. Before making extra payments, you should check the summary plan description and loan policy rules regarding extra loan payment. Some 401(k) plans only allow lump-sum payments if their programmed loan amortization schedule cannot accommodate extra loan payments. In this case, you can set aside the extra payments in a savings account, and pay off the loan in full when you have accumulated enough savings.

Also, some 401(k) plans only allow loan payments through payroll deduction. This means that you cannot make the extra payments from your other assets. If so, you could ask the plan administrator to adjust the withholding amount on the periodic paychecks so that the extra payments can be deducted automatically from your paychecks.

Take a loan

If the new employer allows new employees to take a 401(k) loan, you can take a new loan and use the proceeds to pay back the old loan. You could also rollover your 401(k) into the new employer’s 401(k) and borrow against the retirement savings. While you will still be required to pay off the new loan, you will have more time to repay the loan. The new loan will help you avoid paying taxes and penalties on the unpaid loan if you default. If a new 401(k) loan is not desirable, you can take a bank loan to pay off the unpaid 401(k) loan.