When a 401(k) loan goes unpaid, the IRS treats the failure in one of two ways, and the difference between a deemed distribution and a loan offset decides whether you can save the money through a rollover or simply owe tax on it. A deemed distribution is a paper event: the unpaid balance is taxed as if it were distributed, but no money moves and nothing is eligible for rollover. A loan offset is a real distribution: the plan cancels the debt by reducing your account balance, and that amount can be rolled into an IRA or another plan if you can replace the cash.
Which one applies to you is not a choice. It depends on whether you’ve had what the plan calls a distributable event, and that single fact drives everything else, including your tax bill, your rollover options, and your deadline to act.
What Decides Which One You Get
A loan defaults when you stop making the required payments and miss the plan’s cure period. The IRS lets that cure window run through the end of the calendar quarter after the quarter you missed the payment, though a plan can set a shorter window or none at all.1Internal Revenue Service. 401(k) Plan Fix-It Guide – Participant Loans Do Not Conform to the Requirements of the Plan Document and IRC Section 72(p) Once that deadline passes, the unpaid balance becomes a taxable event.
From there, the sorting question is simple. Have you had a distributable event under the plan, such as leaving your job, reaching the plan’s retirement age, or the plan terminating? If no, the default produces a deemed distribution. If yes, it produces a loan offset. Same unpaid loan, two very different outcomes.
Deemed Distribution: Tax Now, No Cash, No Rollover
A deemed distribution happens when you default while you’re still employed and no distributable event has occurred. The IRS treats the outstanding balance as a distribution for tax purposes, but the money never leaves your account. You owe ordinary income tax on the full unpaid balance in the year the cure period expires. If you’re under 59½, add the 10% early withdrawal penalty on top.2Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
You’re paying tax on money you can’t touch. The plan doesn’t cut a check. Your balance doesn’t drop. The IRS just treats you as if you’d withdrawn the loan amount.
Because no plan assets actually moved, a deemed distribution is not eligible for rollover. The 1099-R instructions state this directly.3Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498 You cannot park the taxed amount in an IRA to undo the hit. That option is gone.
Two other consequences catch people off guard. First, the loan stays on the plan’s books even after it’s been taxed. The unpaid balance continues to count against your $50,000 borrowing cap, so you can’t simply take out a new loan to replace what you just paid tax on. Second, you now need to build tax basis in the taxed amount, or you’ll be taxed again on the same dollars when you eventually take real distributions in retirement. The amount reported on your 1099-R becomes your basis. If the plan allows, you can keep making payments on the defaulted loan after the deemed distribution, and those payments are treated as after-tax contributions that increase your basis.4Internal Revenue Service. Retirement Plans FAQs Regarding Loans
Loan Offset: A Real Distribution You Can Roll Over
A loan offset works differently because an actual distribution of plan assets takes place. When a distributable event occurs with an outstanding loan, the plan satisfies the loan by reducing your account balance by the unpaid amount. The debt is canceled, your balance drops, and the IRS treats the offset as a distribution to you.4Internal Revenue Service. Retirement Plans FAQs Regarding Loans
Common triggers are leaving the job, hitting the plan’s normal retirement age, or the employer terminating the plan.
Because this is a real distribution, it qualifies for rollover. You can move the offset amount into an IRA or another qualified plan and keep the whole balance tax-deferred. The practical complication is that the plan didn’t hand you cash for the offset portion. It kept your money and used it to pay the loan. So to roll over the offset, you have to come up with that amount from outside savings and deposit it into the receiving account yourself. A partial rollover works too. Whatever you don’t replace becomes taxable, and the unreplaced portion is subject to the 10% early withdrawal penalty if you’re under 59½.2Internal Revenue Service. Retirement Topics – Exceptions to Tax on Early Distributions
The QPLO Deadline That Saves Most People
The deadline to roll over a loan offset depends on what caused it. The Tax Cuts and Jobs Act of 2017 created an extended deadline for one specific category: the qualified plan loan offset, or QPLO. A QPLO is an offset that occurs because the plan terminated or because you failed to repay the loan after separating from your employer.5Legal Information Institute. 26 USC 402(c)(3) – Definition: Qualified Plan Loan Offset Amount
If your offset is a QPLO, you have until your federal tax filing deadline for the year of the offset, including extensions, to complete the rollover. For most people that means April 15 of the following year, or October 15 with an extension.6Internal Revenue Service. Plan Loan Offsets
If the offset doesn’t meet the QPLO definition, the standard 60-day rollover window applies instead.7Federal Register. Rollover Rules for Qualified Plan Loan Offset Amounts Most offsets caused by job loss or plan termination will qualify as QPLOs, but confirm with your plan administrator which category applies before you plan your timeline.
How to Tell Which One Happened: Form 1099-R Codes
Your plan administrator reports the event on Form 1099-R, and Box 7 tells you exactly what the IRS thinks occurred.
- Code L means deemed distribution. The outstanding balance appears in Box 1 and Box 2a. A second code, such as Code 1 for an early distribution, may appear alongside. Code L is the flag that this amount cannot be rolled over.3Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498
- Code M means qualified plan loan offset. The offset amount is reported as a regular distribution with Code M added to signal QPLO status. Code M tells you the extended rollover deadline applies.3Internal Revenue Service. 2025 Instructions for Forms 1099-R and 5498
- Standard distribution codes with no Code M indicate a regular loan offset that is still rollover-eligible but limited to the 60-day window.
Verify the code with your plan administrator before filing. A miscoded 1099-R can take months to fix with the IRS, and if a QPLO is reported with the wrong code, you may lose the extended deadline through no fault of your own.
Side by Side
- What it is. Deemed distribution: a tax event with no actual payout. Loan offset: a real reduction of your account balance that cancels the loan.
- When it happens. Deemed distribution: you default while still employed with no distributable event. Loan offset: you default after a distributable event such as leaving the job or the plan terminating.
- Rollover. Deemed distribution: not allowed. Loan offset: allowed if you deposit the equivalent amount into an IRA or another plan from personal funds.
- Deadline. Deemed distribution: none, because rollover isn’t available. QPLO: tax filing deadline including extensions. Non-QPLO offset: 60 days.
- Account effect. Deemed distribution: balance unchanged, but the loan stays on the books and reduces future borrowing capacity. Loan offset: balance permanently reduced by the loan amount.
- Taxes and penalty. Both are ordinary income if not rolled over, and both trigger the 10% penalty under 59½ on the amount not rolled.
What to Do Based on Where You Are
If you’re still employed and have already defaulted, you’re looking at a deemed distribution. The rollover door is closed. Focus on the two things you can still control: confirm the Code L amount matches what you expect, and ask your plan whether you can continue making payments on the defaulted loan to build after-tax basis and avoid being taxed on the same dollars again in retirement.
If you’re about to leave a job or your employer is terminating the plan with a loan outstanding, you’re headed for a loan offset. The best move is to repay the loan in full before separation if you can. If you can’t, start lining up the funds you’ll need to roll the offset amount into an IRA before your tax filing deadline. Even a partial rollover reduces the taxable amount and the penalty exposure. Wait for the 1099-R, confirm Code M appears, and complete the rollover within the window the code gives you.