With sweeping tax reform going into full effect last month, many 401(k) participants are wondering how and if their plans will be affected. The answer to that question is: not much. The biggest news for 401(k) owners with regard to the new tax laws is the extension of payback dates on outstanding loans.
Prior to the tax reform bill, participants who’d left employment with an outstanding loan were expected to pay off the balance within 60 days of separation or face a 10% withdrawal penalty and have the distribution be considered taxable income. The new bill provides a greater window, as individuals now have until the filing deadline of their individual tax return to avoid the tax consequences of a “deemed distribution.” For example, if an employee is terminated today with an outstanding loan, he or she would have until April 15, 2019, to pay it back, or October 15, 2019, if an extension is requested.
The new law benefits both employees and employers. Extending the loan repayment deadline gives participants more time to pay off outstanding loans and, more importantly, incentivizes an employee to take out a loan rather than process a hardship withdrawal, which incurs both a withdrawal expense and a taxable distribution subject to penalty. The tax reform is also good news for employers since it ultimately reduces the leakage of funds in 401(k) plans.