What Happens If You Fall Behind on 401(k) Loan Payments?

Taking a loan from your 401(k) can be a convenient way to borrow money, since you’re essentially borrowing from yourself. But just like any loan, staying on schedule with your repayments is crucial. If you fall behind, there are strict IRS rules that could result in taxes and penalties.

Here’s what to expect if your 401(k) loan payments become overdue—and what you can do to avoid default.

When you take a 401(k) loan:

• Repayments are usually made through payroll deductions

• Payments are made at least quarterly, often every paycheck

• Each payment includes both principal and interest, which go back into your account

The loan is amortized over a set term, typically up to 5 years (longer if used to purchase a primary residence).

Missing a single payment may not immediately trigger default—but if payments aren’t caught up within a specific window, the loan becomes delinquent and eventually defaults.

The Grace Period

You generally have until the end of the calendar quarter following the quarter in which the missed payment occurred to make up the missed amount.

Example:

• You miss a payment in May (Q2)

• You must catch up by September 30 (end of Q3)

If you don’t, the loan is treated as a deemed distribution.

A deemed distribution means the IRS treats the outstanding loan balance as if you withdrew it from your account. This has major consequences:

• The remaining balance becomes taxable income in the year of the default

• If you're under age 59½, it’s also subject to a 10% early withdrawal penalty

The loan balance stays in your account as a liability, but no further payments are made. The unpaid loan amount will eventually reduce your account value by being offset.

If you separate from your employer:

• Loan repayments typically stop since payroll deductions end

• Your plan may allow a grace period to repay the loan in full

• If not repaid within the plan’s deadline, the balance will be defaulted and reported as a taxable distribution

Under current IRS rules, you have until your tax filing deadline (plus extensions) to repay the loan via rollover to avoid taxes, but this option must be handled carefully—consult a tax advisor if considering it.

• Monitor payroll deductions to confirm repayments are processing correctly

• Contact NestEggs immediately if you switch to unpaid leave, disability leave, or change employment status

• Ask about suspension rules for qualifying leaves (e.g., military leave or FMLA)

• Keep copies of your loan documents for reference

If you're behind on payments or at risk of default:

• Contact NestEggs

• Ask if your plan allows loan repayment catch-up or full payoff options

• Speak with a tax advisor to understand your obligations if default occurs