You can stop paying your 401k loan, but the IRS will treat the unpaid balance as a taxable distribution, and if you’re under 59½ you’ll also owe a 10% early withdrawal penalty on top of the income tax. Whether you can soften or avoid that hit depends on how quickly you act, whether you’re still with the employer, and whether the shortfall qualifies for a rollover.
The Cure Period Before Anything Goes Wrong
A single missed payment doesn’t automatically default the loan. Federal rules let plans offer a cure period that runs through the last day of the calendar quarter following the quarter in which you missed the payment.1Internal Revenue Service. Plan Loan Cure Period In practice:
- Payment missed in Q1 (Jan–Mar): cure deadline is June 30
- Payment missed in Q2 (Apr–Jun): cure deadline is September 30
- Payment missed in Q3 (Jul–Sep): cure deadline is December 31
- Payment missed in Q4 (Oct–Dec): cure deadline is March 31 of the following year
Plans aren’t required to give the full cure period. Some offer a shorter window, some none at all, so check your plan document. If you catch up on the missed payments before the cure period ends, the IRS treats the loan as though nothing happened.1Internal Revenue Service. Plan Loan Cure Period
Once the cure period runs out without full payment, the entire outstanding balance plus accrued interest becomes a deemed distribution, and catch-up payments alone can no longer fix it.2Internal Revenue Service. Deemed Distributions – Participant Loans
What the Tax Bill Looks Like
Once the loan defaults, the plan reports the unpaid balance on Form 1099-R, and you include it as ordinary income on your federal return.2Internal Revenue Service. Deemed Distributions – Participant Loans For someone in the 22% bracket with a $10,000 unpaid balance, that’s $2,200 in federal income tax. Most states with an income tax will want their share too.
If you’re under 59½, the IRS adds a 10% early distribution penalty. Section 72(t) applies to a deemed distribution in the same manner as if you had taken an actual withdrawal.3GovInfo. 26 CFR 1.72(p)-1 On the same $10,000 balance, that’s another $1,000. Combined federal tax and penalty already run past $3,200 before state tax.
A few exceptions to the 10% penalty exist. If you separate from service during or after the year you turn 55, the early distribution penalty generally doesn’t apply to distributions from that employer’s plan. Disability and certain other qualifying events can also eliminate the penalty. The income tax still applies regardless.
One thing to know if you keep the account: a deemed distribution doesn’t necessarily end your obligation to repay under the plan’s terms. Any late payments you make afterward increase your tax basis in the plan, so a portion of your eventual retirement withdrawals comes out untaxed to offset the tax you already paid.4Internal Revenue Service. Plan Loan Failures and Deemed Distributions5Internal Revenue Service. Retirement Plans FAQs Regarding Loans
If You’ve Left the Job: The Rollover Escape
Leaving your employer is where most 401k loan situations unravel. Payroll deduction stops, and most plans won’t accept ongoing payments from former employees because repayment is tied to the payroll system. The plan will typically demand a lump-sum payoff, and if you can’t pay, it reduces your account balance by the unpaid loan amount.
That reduction is called a plan loan offset, and it matters because the tax code treats it differently from a deemed distribution. An offset is treated as an actual distribution and is eligible for rollover, while a pure deemed distribution is not.6Internal Revenue Service. Plan Loan Offsets
Here’s the escape hatch. If the offset happened because you separated from service or the plan terminated, the shortfall counts as a qualified plan loan offset (QPLO). Under the Tax Cuts and Jobs Act, you have until the due date of your federal income tax return for the year of the offset, including extensions, to deposit that amount into an IRA or another eligible retirement plan.6Internal Revenue Service. Plan Loan Offsets For an offset in 2026, that generally means April 15, 2027, or October 15, 2027 with an extension.7Federal Register. Rollover Rules for Qualified Plan Loan Offset Amounts
You have to come up with the cash from another source, since the money that would have covered the loan is no longer in your 401k. But depositing the full offset amount into the rollover account by the deadline cancels the taxable event and eliminates the 10% penalty.
Two limits on this. If the offset wasn’t triggered by separation from service or plan termination, the standard 60-day rollover window applies instead.6Internal Revenue Service. Plan Loan Offsets And a pure deemed distribution, where you simply stopped paying while still employed and the cure period ran out, can’t be rolled over at all.5Internal Revenue Service. Retirement Plans FAQs Regarding Loans
Legitimate Reasons to Pause Payments
Some situations let you stop paying without triggering a default at all.
Unpaid leave of absence. Your plan can suspend loan repayments for up to one year. When you return, you make up the missed payments by increasing each remaining payment or paying a lump sum, so the loan still finishes within the original five-year term.5Internal Revenue Service. Retirement Plans FAQs Regarding Loans
Military service. Your plan can suspend repayments for the entire period of military service, and the repayment deadline extends by the length of that service. Serve for 18 months, get an extra 18 months to repay. Interest during military service is capped at 6% if you give your plan sponsor a copy of your orders.8Internal Revenue Service. Retirement Plans FAQs Regarding USERRA and SSCRA
Federally declared disaster. If you live in an area affected by a federally declared disaster, SECURE 2.0 allows your plan to delay any loan payments due between the start of the incident period and 180 days after it ends by up to one year. Payments resume after the suspension, adjusted for the delay and accrued interest.9Internal Revenue Service. Disaster Relief Frequently Asked Questions – Retirement Plans and IRAs Under the SECURE 2.0 Act of 2022p>
What to Do Before You Default
If you know you can’t keep up, act before the cure period runs out. Once a deemed distribution is on the books, options narrow fast.
- Ask about reamortizing the loan. Some plans allow you to restructure by increasing remaining installments or making a partial catch-up, as long as the loan still closes within the original five-year term.10Internal Revenue Service. 401(k) Plan Fix-It Guide – Participant Loans
- Use the full cure period if you’ve already missed a payment. Confirm the exact deadline with your plan administrator.
- Request a leave-of-absence suspension if you qualify.
- If you’re leaving your job and can scrape together the cash, pay off the balance before the plan processes the offset.
- If the offset has already happened at separation, treat the tax filing deadline as a rollover deadline, not a tax deadline. Getting that money into an IRA by then wipes out the tax and penalty.
The worst outcome is doing nothing and being surprised by a 1099-R the following January. A phone call to your plan administrator before the cure period expires almost always beats the alternative.