Borrowing from a 401k can feel like a short-term fix, but it may lead to unexpected taxes if employment changes or payments stop.
This article explains two situations that often cause confusion: a loan default that turns into a taxable deemed distribution, and a plan loan offset (including a Qualified Plan Loan Offset, or QPLO) where part of your account balance repays the loan automatically.
In 2025, this distinction is important. Deemed distributions are generally taxable right away. Offsets, on the other hand, may be rolled over to another eligible retirement account, and QPLOs receive extra time to complete that rollover until your tax-return due date, including extensions.
You will learn what events trigger each outcome, how they appear on Form 1099-R, and what options may help you reduce avoidable tax or penalties. The goal is to help you understand the rules and protect your retirement savings before making any loan or rollover decision.
📌 Also read: 401k Hardship Withdrawal vs 401k Loan: Which One Is Better?
What Happens When a 401k Loan Goes Into Default
A 401k loan is meant to be repaid through regular installments, usually deducted from payroll. When payments stop or fall behind, the loan can lose its tax-qualified status. Once that happens, the unpaid balance and accrued interest are treated as a taxable deemed distribution for that year under IRC Section 72.
Most plans provide a short cure period, ending no later than the last day of the quarter following the missed payment, to catch up on overdue installments. If repayment is not made by then, the plan must report a deemed distribution, and the borrower owes ordinary income tax on that amount.
📝 Note: This does not mean the loan is forgiven or removed from your account. The amount remains outstanding until repaid or offset, even though it is already taxable.
Reporting and Codes (Form 1099-R, Code L)
When a loan becomes a deemed distribution, the plan reports it on Form 1099-R using Code L in Box 7. The distribution is not eligible for rollover, and the taxable amount appears in Boxes 1 and 2a. Depending on your age, another code may be added:
✅ Code 1 if the borrower is under age 59½ (potentially triggering the 10% additional tax).
✅ Code 7 if the borrower is age 59½ or older and the distribution is considered normal.
Interest that continues to accrue after the deemed distribution is not reported on Form 1099-R and remains part of the unpaid balance.
📝 Note: Keep this form with your tax records. The IRS uses it to match reported income, and missing it may lead to an underreporting notice.
Common Default Triggers and Fixes
A deemed distribution can occur for several reasons beyond a missed payment. The most frequent triggers include:
- Missed amortized repayments beyond the allowed cure period.
- Loan terms that break IRS requirements, such as exceeding the five-year maximum term (unless it is for a principal residence) or failing to make level, at-least-quarterly payments.
- Borrowing more than the legal limit — the lesser of $50,000 (with a 12-month look-back adjustment) or 50% of your vested balance, though plans may allow a $10,000 minimum safe-harbor loan if properly secured by collateral.
- No written or electronic loan agreement detailing the amount, issue date, and repayment schedule.
Employers and plan administrators have some corrective options under the IRS Employee Plans Compliance Resolution System (EPCRS) and the related Fix-It guidance:
✅ Accept a lump-sum catch-up payment that includes missed principal and interest.
✅ Re-amortize the outstanding balance over the remaining allowed term.
✅ Combine both methods if the missed payments span several months.
If the default results from an administrative or payroll error, employers may contribute part of the corrective payment to restore the account. Once the maximum statutory loan term has expired, correction is no longer available. The plan must issue Form 1099-R for that year and report the deemed distribution.
📝 Note: Addressing repayment errors quickly may limit tax exposure and keep the plan in compliance with IRS rules.
Plan Loan Offsets and Qualified Plan Loan Offsets (QPLOs)
When you leave a job or your retirement plan ends, the plan may automatically repay your outstanding 401k loan using your account balance. This action is called a plan loan offset. It is treated as an actual distribution, not a deemed one, because the amount is directly subtracted from your balance to repay the loan.
A Qualified Plan Loan Offset (QPLO) is a special kind of offset that happens because of a job separation or plan termination. The key benefit is timing: QPLOs generally give you more time to roll over the offset amount into another eligible retirement plan compared with ordinary offsets.
📝 Note: A plan loan offset can create a taxable event if you do not roll it over. Understanding the type of offset you received helps determine your deadline and tax impact.
How 401k Loan Offsets Are Reported on Form 1099-R
Plan administrators must report a loan offset on Form 1099-R as an actual distribution from the plan. If the offset qualifies as a QPLO, it is still reported as a distribution, but Code M must appear in Box 7.
Do not confuse these codes:
- Code M identifies a Qualified Plan Loan Offset.
- Code L applies only to deemed distributions under Section 72(p) and should never be used for offsets.
The IRS guidance clarifies that a QPLO occurs when the offset is tied directly to employment termination or plan closure. Using the correct code ensures your rollover eligibility is clear to the IRS.
📝 Note: Always keep a copy of your Form 1099-R. The code on the form determines how long you have to complete a rollover and whether the offset is taxable.
Rollover Deadlines for Offsets and QPLOs
Most distributions that are eligible for rollover must be completed within 60 days of receiving the funds. That rule applies to ordinary plan loan offsets.
If the offset qualifies as a QPLO, you have extra time, until your federal tax-return due date for that year, including extensions, to finish the rollover. This extended window gives you flexibility if the offset happens late in the year or during a job transition.
To qualify, the QPLO must:
✅ Result directly from plan termination or job separation.
✅ Involve a loan that was in good standing immediately before that event.
📝 Note: Rolling over the offset amount within the allowed period prevents it from being taxed as income and helps preserve your retirement savings for the future.
Next Steps for 401k Loan Taxes and Rollovers
If your 401k loan repayment goes off track, the next steps depend on what type of event occurred and how it is reported. Use the checklist below to understand your situation and what actions may help reduce potential taxes or penalties.
Step 1 — Identify the event
Determine whether the issue is a deemed distribution or a loan offset.
- If you missed payments and did not catch up within the plan’s cure period, it is a deemed distribution. The unpaid balance is taxable for that year and cannot be rolled over.
- If your account balance was reduced after you left your job or your plan ended, it is an offset, which is treated as an actual distribution.
- If that offset qualifies as a Qualified Plan Loan Offset (QPLO), you generally have until your tax-return due date (with extensions) to roll it over.
📝 Note: Always confirm your plan’s terms and any notices you received from your plan administrator. These determine your official classification and timeline.
Step 2 — Review your Form 1099-R
Check Box 7 for the distribution code.
- Code L means a deemed distribution.
- Code M means a qualified plan loan offset.
This code affects whether you can roll over the amount and what deadlines apply.
Step 3 — Plan your rollover (if eligible)
If your distribution qualifies for rollover:
- Standard rollovers must be completed within 60 days of the offset.
- QPLOs can be rolled over up to your tax-return due date, including extensions.
- Direct rollovers between trustees are preferred since they avoid the 20% withholding that applies to indirect rollovers. Before initiating, confirm that the new plan or IRA accepts rollover funds.
Step 4 — Estimate taxes and penalties
If you are under age 59½, and the amount is taxable, it may also be subject to the 10% additional tax under Section 72(t) unless an exception applies. Keep your Form 1099-R and supporting records for your tax filing.
📝 Note: Rolling over an eligible offset within the allowed period helps keep your retirement savings tax-deferred and avoids losing part of the balance to penalties.
401k Loan FAQs
What is a 401k loan default or offset?
A default is a deemed distribution that occurs when payments are missed and not cured within the required period. An offset happens when your plan uses part of your account balance to repay the loan. If the offset is due to job separation or plan termination, it may qualify as a QPLO, giving you extra rollover time.
What happens if a 401k loan goes into default?
The unpaid amount becomes taxable for that year and is reported on Form 1099-R with Code L. It cannot be rolled over, and if you are under age 59 1⁄2, you may owe the 10% early distribution tax unless an exception applies.
What happens when a loan is offset?
The plan reports it as an actual distribution. If it qualifies as a QPLO, you may roll it over by your tax-return due date, including extensions. If it is a regular offset, the usual 60-day rollover rule applies.
Wrapping It Up
A 401k loan can help in a pinch, but how it ends matters just as much as how it begins. A default occurs when loan payments fall behind and are not corrected, creating a deemed distribution that becomes taxable right away. An offset happens when your plan balance is used to repay the loan, often after leaving your job. If it meets the rules for a Qualified Plan Loan Offset (QPLO), you get more time to roll it over.
Pay close attention to timing and paperwork. Most rollovers must be done within 60 days, but QPLOs can be completed up to your tax-return due date, including extensions. Review your Form 1099-R, note whether it shows Code L or Code M, and confirm that your receiving plan or IRA will accept the rollover.
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