Retiring From the NYPD With a 457 Loan
The loan offset, and the tax you can undo

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The loan comes due when you leave

While you’re working, a loan from your Deferred Comp 457 is paid back through payroll. The Plan’s loan guide is plain about what happens when the paychecks stop: loans are “due and payable upon the expiration of the loan term or your severance from employment with the City, whichever occurs first.”

That leaves two ways to close it. You can pay off the whole balance; the guide says payoffs are accepted only for the entire balance, by certified check, bank check or postal money order. Or you can file the Plan’s 457/401(k) Loan Offset Form, which lets the Plan take the unpaid balance out of your account.

This is about a loan from Deferred Comp. A pension loan from the Police Pension Fund is a different plan with different rules; our pension loans lesson covers those.

What the offset costs

An offset is treated as money paid out of the plan. The guide says “A Form 1099-R will be issued to you for the total outstanding loan balance for the year in which the 457/401(k) Loan Offset Form was received.” The loan was funded from your pre-tax money (the guide says it comes from “a cash-out of your pre-tax contributions”), so that balance counts as ordinary income for the year the Plan receives the form.

There’s no 10% penalty on it. The IRS says that “any distribution from such plan isn’t subject to the 10% additional tax on early distributions,” meaning a state or local government 457 plan (IRS Topic 558). The one exception is money that came into the 457 from a 401(k), a 403(b), another qualified plan or an IRA. The guide names a 10% penalty only for a 401(k) loan offset taken before 59½.

No penalty isn’t no tax, though. The offset is income in the year it counts.

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The tax you can undo

When a loan is offset because you left the job, the tax code calls it a qualified plan loan offset. You can roll the offset amount into a traditional IRA, or another plan that accepts rollovers, and the rollover keeps it out of your taxable income. The deadline isn’t the usual 60 days. It’s your tax filing due date, extensions included, for the year the offset counts in (Internal Revenue Code section 402(c)(3)(C)).

Two conditions come from the Treasury regulation. The loan has to have been in good standing right before you left, and the offset has to happen within a year after you leave (26 CFR 1.402(c)-2(g)). An offset later than that gets only the 60-day window. The regulation also says that an offset “is an actual distribution, not a deemed distribution,” which is what makes it eligible to roll over.

Government 457 plans are covered. The rule applies to a “qualified employer plan,” which the tax code says “shall include any plan which was (or was determined to be) a qualified employer plan or a government plan,” and section 457(e)(16) applies the same rollover rules to a government 457.

The catch is cash. You spent the loan money when you took the loan, so the rollover has to come from other money. Know where it will come from before your last day.

One more thing before you roll it: money in an IRA follows IRA rules. Taken out before 59½, it can carry the 10% penalty that money in a government 457 doesn’t. Deferred Comp’s own withdrawals page warns that rolled-over funds “may become subject to a 10% early withdrawal penalty.”

Check the 1099-R before you count on the longer deadline

The IRS tells plans to report a qualified plan loan offset with code M in box 7 of the 1099-R. Code L is for “Loans treated as deemed distributions under section 72(p),” and the IRS tells plans not to use it for a plan loan offset. A deemed distribution can’t be rolled over at all.

The Deferred Comp guide, in one place, describes the offset form as letting the Plan offset the loan “as a deemed distribution.” That’s the guide’s wording, not the tax rule, but it’s reason enough to ask the Plan how your offset will be coded before you rely on the longer deadline.

Before your last day

• Get your loan payoff amount from Deferred Comp.
• Work out which way you’ll close it: pay it off, offset it and roll the same amount into an IRA by the deadline, or offset it and pay the tax.
• If you’ll roll it over, line up the cash and ask how the 1099-R will be coded.
• Take the numbers to your tax professional. What the offset would cost you in tax depends on the rest of your income that year.

Common questions

Is a 457 loan offset taxable?

Yes. The Plan issues a Form 1099-R for the whole unpaid balance for the year it receives your Loan Offset Form, and the amount is ordinary income for that year unless you roll it over.

Is there a 10% penalty on a 457 loan offset?

Not on money in a government 457, at any age. The exception is money that was rolled into the 457 from a 401(k), a 403(b), another qualified plan or an IRA.

How long do I have to roll over a 457 loan offset?

If the loan was in good standing when you left and the offset happens within a year after you leave, until your tax filing due date for that year, extensions included. Otherwise 60 days.

Can I keep paying the loan after I retire?

The guide says that when you leave City service, loans become “immediately due and payable,” and that payoffs are accepted only for the entire balance.

Does this apply to a pension loan from the Police Pension Fund?

No. That’s a different plan with its own rules. See the pension loans lesson.

Retiring from the FDNY? Firefighters are in a separate pension fund. Run the FDNY pension calculator or get the free FDNY Pension Book.

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