Will the amount of an outstanding loan from my 401(k) be deducted from the total taxable amount of my 401(k) at retirement?
I have an outstanding loan from my 401(k) at the time of my retirement. I understand that I will pay taxes on that loan as earned income. Will the amount of my outstanding loan be deducted from my current 401(k) amount when I withdraw a lump sum at retirement? Or is the entire amount that's in my 401(k) currently subject to the 20% tax withholding?
You are correct, the amount of your outstanding loan will be subject to income taxes at the time of your loan default (when you stop paying it back). The remaining balance is subject to income tax at your ordinary income tax rate. The 20% withholding comes into play if you take money directly out of the plan as a payment to you. If you roll the 401(k) to an IRA, there is no tax for that transaction. As you take money out of the IRA, you can tell your investment company the percentage you want withheld at each distribution.
Try to only take out money when you need it, not in one big lump sum. That will only increase your taxes in one year, when spreading out the distributions could keep you in a lower tax bracket.
If you have an outstanding loan and stop making payments, the balance of the loan is taxable as income in the year you stop making payments. It does not impact the current balance of your 401k since it has already been withdrawn. If you roll over the remaining balance into an IRA, the rollover amount is not taxed. If you withdraw the amount and deposit it into a NON IRA (like a bank account for example) the amount you withdraw is taxed as ordinary income. The tax rate will be your current tax rate. If you are over 59.5, you will not incur a 10% penalty.
For starters you should check to see if your employer allows you to keep paying even after separation. Not suggesting that is the move or not, but at very least this provides you options. Now assuming it doesn't and you are not subject to any pre 59.5 or 55 penalties you will be subject to ordinary income tax, at your taxable rate, on the defaulting amount. If you had lets say $500,000 in your 401(k) took out a $100,000 loan and have paid back $50,000 then you retire the remaining $50,000 will be additional ordinary income and your account balance would be $450,000. Hope that makes sense and helps!