He Retired at 61 With a $28,000 Loan Still Out Against His 401(k). The Plan Called It Due. When He Couldn’t Repay, the IRS Taxed $28,000 He’d Spent Years Ago

When a worker retires before paying off a 401(k) loan, the unpaid balance can create problems. For example, a 61-year-old may still owe $28,000, and the IRS’ rules and each plan’s documents determine the outcome; for many retirees, it ends in a tax bill on money they spent years earlier.

How a 401(k) Loan Turns Into Taxable Income

Federal rules generally let a participant borrow the lesser of $50,000 or 50% of the vested account balance. Most loans must be paid back within five years, usually through payroll deductions. When the job ends, the paycheck that carried those payments ends too. Many plans then call the loan due or reduce the account by the unpaid amount. The IRS calls that reduction a plan loan offset.

An offset still counts as a distribution, and the $28,000 borrowed years ago becomes taxable income in the year he retired. At 61, he was already past the 59½ threshold, so the additional 10% early withdrawal penalty did not apply. Ordinary income tax still did.

What a $28,000 Offset Costs at Tax Time

The bill’s size depends on the retiree’s bracket. In the 12% federal bracket, $28,000 of added income produces about $3,360 in federal tax. State income tax, where it applies, comes on top of that. Also worth knowing: in the 22% bracket, the same offset produces about $6,160 in federal tax. The retiree owes this even though he gets no new cash. The money left the account when he borrowed it, and the tax comes due when the plan closes the loan.

Balances Near Retirement Make the Hit Larger Than It Looks

Fidelity data show the average 401(k) balance for savers aged 60 to 64 was $246,500 at the end of 2024. A $28,000 offset equals about 11% of that figure. An average gets pulled up by a small number of very large accounts, so the median saver, the one in the middle, holds less. For a typical near-retiree, the same loan would take a larger share of the account.

Borrowing from retirement plans is common. In one 2025 retirement survey, 21% of respondents said they had taken 401(k) loans or hardship withdrawals, compared with 26% in 2024. Consumer finance expert Clark Howard has pointed to another cost: “A lot of employers won’t let you contribute to your 401(k) while you have that outstanding loan.”

Thin Cash Cushions Limit Repayment Options

Paying off the loan at retirement avoids the tax, but that takes cash. Bureau of Economic Analysis data put the personal savings rate at 2.8% in the second quarter of 2026. That compares with 6.2% in the first quarter of 2024.

Spending has gone up over the same period. The Bureau of Labor Statistics Consumer Expenditure Survey shows average household spending of $78,535 in 2024, up from $72,973 in 2022. A household saving a smaller share of rising income may not have $28,000 in cash when a job ends.

A Rollover Deadline Many Retirees Miss

You can roll over an offset to avoid the tax bill. According to the IRS, starting January 1, 2018, an offset caused by leaving a job or by the plan ending gives the participant until the tax return due date, including extensions, to put the same amount into an IRA or another eligible plan. The usual limit is 60 days. With an extension, the deadline typically moves from April 15 to October 15.

If the retiree in this example deposited $28,000 of his own money into a rollover IRA by that deadline, the offset would not be taxed. The catch is that the deposit has to come from savings outside the plan, which brings the cash problem back. The offset also appears on a Form 1099-R, and if you do nothing, the full amount is taxed as income.

Loan Decisions That Matter Before the Last Paycheck

• Plan documents spell out what happens to a loan when employment ends. Some plans let former employees keep repaying on the original schedule, and others call the balance due right away.
• Workers aged 60 to 63 can contribute up to $35,750 in 2026 under the higher catch-up limit. Paying off a loan before retiring can keep those years open for saving.
• Setting cash aside ahead of time for the extended rollover deadline turns a taxable offset into a rollover.

A 401(k) loan feels like borrowing from yourself while payroll deductions keep it on schedule. Once the job ends, the unpaid balance can be taxed as a distribution. With household savings rates near the low end of recent levels, the deadline tied to the retirement date may matter as much as the loan’s interest rate (this offset rule is one of several IRS quirks we mapped in a free retirement tax guide here: The Retiree’s Tax Trap Map).

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