Leave of Absence and Affect on 401k Loan Repayments

You work very hard. And sometimes you need to take a break from work in order to recharge yourself. Other times your health, or the health of a loved one may force you to take a break from work.

Taking a leave of absence (LOA) is fairly commonplace nowadays, but it is sometimes a difficult decision to make. You have a laundry list of things you need to consider before going on leave, but if you have a 401k loan, make sure to add that to the list as well.

There’s good news and there’s bad news. The good news is that you can postpone making payments to your 401k loan for 12 months while you are on leave without facing the possibility of your loan defaulting and becoming a taxable event. If you choose, you can even arrange to make payments on your loan while you are out in order to stay current. Work with your benefits office to determine best repayment method.

The bad news is that when you return from leave, or when 12 months have gone by (whichever comes first) you have to play catch up. Since the loan still must be repaid by the end date you chose when you took the loan out, you will either need to make a lump sum payment to become current, or your loan must be re-amortized to maintain the same payoff date.

A re-amortization is generally the more common option since you might not be able to afford to make a lump sum payment – especially if you were out of work for 12 months. Although this is stating the obvious, remember that when your loan is re-amortized, your payments will increase substantially. There isn’t much you can do about this. The increased payments are required in order to maintain a consistent payoff date.

If your original loan payoff date comes due while you are on leave, you must pay the whole thing off then. You cannot wait until the end of your 12 month period to make the payment. If you fail to do this, your loan will default and be treated as a taxable distribution to you in that year, and you will likely owe a 10% penalty, too.

Military Leave of Absence

There is one general exception to the above rules. If you went on a leave of absence for military reasons, you can postpone making repayments for the entire time you are on leave, not just the standard 12 month maximum.

When you return to work, your payments will begin again and continue from the point they left off. The biggest thing to note is that usually any accrued interest will be tacked on to the outstanding loan balance, making payments slightly higher.

You can avoid this by continuing to make payments while you are on leave if that is something that is feasible, but it is certainly not required. The upside is that your loan will not have to be re-amortized to account for the “missed” repayments.