Since loan payments are simply deducted from the employee’s net check, there is no special taxability or reporting rules.
A 401(k) plan is a defined contribution retirement plan offered by an employer. A 401(k) plan is funded by employee contributions, and often, matching contributions from the employer. The major benefit of these plans is that the contributions are treated as pretax and the funds grow tax-free until withdrawn.
Rules and regulations for 401(k) plans are established by the US Tax Code [refer to IRC section 401(k)]. Private-sector employers are allowed to sponsor "cash or deferred arrangements (CODAs)" for their employees. Under a CODA, eligible employees can elect to receive certain salary payments as taxable income (e.g. cash), or have the employer contribute the salary to a qualified retirement plan.
Contributions to a 401(k) plan can be made in several ways:
employee pretax contributions (elective deferrals)
employee voluntary post-tax contributions, or
employer pretax contributions (optional).
Taxability for federal income tax purposes varies depending on the type of contribution being made. If the 401(k) plan is funded with employee pretax contributions, these contributions are only exempt up to an annual limit for federal income tax purposes. An employer’s plan may place additional restrictions on the amount employees can defer that are lower than the IRS limit.
Participants, age 50 or older by the end of the calendar year, can make additional “catch-up” contributions. For federal taxation purposes, these additional contributions are taxed in the same manner as “regular” pretax contributions to a 401(k) plan. The individual is allowed a larger salary deferral limit when they are catch up eligible. In addition, employers can make “matching contributions” on the catch-up contributions.
Employee pretax contributions, including catch-up contributions, to a 401(k) plan are considered taxable wages for the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act (FUTA) [refer to IRC sections 3121(v)(1)(A) and 3306(r)(1)(A)].
Some employers allow employees to make post-tax contributions to a 401(k) plan after they reach the annual limit for elective deferrals.
Employer pretax contributions may take the form of either:
matching contributions, which are designed to match amounts contributed by employees (for example, 50 cents for each dollar an employee elects to defer under the plan), or
non-elective contributions, which are employer contributions that are made regardless of any election or contribution by the employees.
A 401(k) plan may include a loan feature that allows employees limited, penalty-free access to savings before age 59½. The employer can restrict loans for certain purposes. When a loan is obtained, the employee is required to pay the loan back with regular payments (usually payroll deductions).
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Since loan payments are simply deducted from the employee’s net check, there is no special taxability or reporting rules. |
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Contribution |
Federal Income Tax |
Social Security and Medicare |
Federal Withholding |
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Employee pretax contributions (including catch up contributions) to a 401(k) plan |
exempt up to annual limit |
taxable |
taxable |
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Employer pretax contributions to a 401(k) plan |
exempt |
exempt |
exempt |
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Employee post-tax contributions to a 401(k) plan |
taxable |
taxable |
taxable |