1099-R distribution

[Pacun]

This happened on a small scale.

I have been working for the same company without interruptions for 20 years. in 2012, I had 200K in my 401k  and I got a loan for $50K. For some reason, the loan defaulted and custodian issued a 1099-R for 10K in 2015. I had to pay taxes and penalty on that distribution. Last month, I tried to get another loan and they told me that I had to pay the 10K for the defaulted loan.  I was planning to get a $25K loan but since I have to pay back the defaulted loan in order for the next loan to be approved, I will now have to get $35K.

I have argued with the custodian that since they issued a 1099-R, the loan should be cleared and they said NO. I have also asked if those 10K will be invested in a 401k Roth and they said NO. I have told them that the 10K is in different category than the rest of my money and they said NO. I told them that they were doing a "not permitted" transaction and they said NO.

I understand that the loan repayment comes from "already taxed" money but no 1099-R are issued when the loans are repaid. I feel that I will have to pay those 10K from "already taxed" money and in addition I got a 1099-R to which I paid taxes and penalty because I am not 59.5 years old.  Am I wrong?

 

[Gail in Virginia]

From the instructions for Form 1099R regarding loans treated as distributions:

Subsequent repayments. If a participant makes any cash repayments on a loan that was reported on Form 1099-R as a deemed distribution, the repayments increase the participant's tax basis in the plan as if the repayments were after-tax contributions. However, such repayments are not treated as after-tax contributions for purposes of section 401(m) or 415(c)(2)(B)

 

If you show them the instructions, do you think they will realize that it does have to be treated as paid with after-tax money?

[Pacun]

Basically what I understand from the your post is that the plan administrator is correct in my case. It is up to me to keep records to prove that I have a basis on my 401k plan. That's interesting that I will have to show the IRS 30 years later that I have a basis on my 401k.

How will I calculate earnings on that money (my basis)? It becomes a hard task. I am glad it is not that much money that I have to send to cover the defaulted loan.

 

[Gail in Virginia]

I don't think that is what I was saying, Pacun.  The instructions for 1099R do say that repayment of the loan is after tax money and creates basis.  if the plan does not allow for after tax contributions, I don't think that they should allow you to repay the loan after it is deemed a distribution.  If it does allow for after tax contributions, they must have a mechanism for tracking those and I would think they could track this the same way. 

As far as tracking earnings on that money, I am not sure that matters.  Your basis will remain the same, and the earnings, being tax deferred regardless of the source, will be taxable.  If this wasn't Roth money to start with, I don't think repaying the loan will change it to Roth money - I would expect it to be just an after tax contribution to a regular 4021(k) or IRA account.  But I don't have any kind of citation for that, even an impermissible one like a pub. 

[Roberts]

When they issued you the 1099r, they didn't include in the taxable amount the interest you failed to pay yourself on the loan. That amount is generally forever included as a balance owed on the 401k. That amount must be paid "to yourself" before you are allowed to take out another loan. I think it's referred to as a loan receivable or something like that. 

 

While you are an active employee - the 401k rules don't allow distributions from retirement plans so they came up with this loan program. They are required to receive the interest owed before another loan is made to keep within the IRS rules for a 401(k).

 

[Pacun]

Perfect explanations. Thank you both.