Q. I have not worked since fall 2011. I’m on leave without pay with the Postal Service. Currently on disability retirement approved by Social Security and the Postal Service. The Office of Personnel Management has until November to finalize the disability retirement. On Sept. 23, I default on my Thrift Savings Plan personal loan ($5,300).
I am entitled to agency retirement pay of $1,645 per month but cannot be paid until OPM acts. Social Security is roughly ¼ pay, and I cannot realistically pay the catch-up amount and the two monthly loan payments for at least two months. At that time, I should be in a position to repay the entire loan (due to the situation explained below).
If I default on the outstanding balance BUT in November, OPM approves my lump-sum payment due for the time not worked and entitled to pay (which depending on what they say will either be September 2011, when I last worked, or March 2012, when I exhausted my annual time and sick days) and I then repay the outstanding balance in its entirety prior to year end, thereby negating the loan default, would the default status then be changed to paid and the taxable distribution then be nullified?
In my mind, if I repay the loan after default but before year end, I should prevent any Internal Revenue Service action regarding the early withdrawal penalty. I have no issues with extra interest or costs associated with my problem but don’t wish to throw away $500 if I can avoid it.
I have an appointment with a tax attorney to try to sort this out, but if you have had any experience in this, I would appreciate a response so I know what to prepare for.
A. I can’t advise you on your specific situation, and what an attorney may or may not be able to accomplish for you. But in general, once the loan is declared a taxable distribution, it cannot be repaid. You may be able to roll the declared distribution amount over to an IRA to defer the tax and avoid any early withdrawal penalty, however.