My son had a loss of $10,000 in his 401(k) last year. He now has a loan for 50% of the balance left in his account. If he loses his job, he will have to pay taxes and a penalty on the amount of the loan. Will the $10,000 loss come into play in the event that he doesn't repay the loan and pays taxes and penalty?

Sonia Cameron, Levering, Mich.

Unfortunately, the loss in your son's 401(k) account is irrelevant to any payment of taxes and penalties resulting from his not paying back the 401(k) loan, says Lisa Van Fleet , a lawyer with Bryan Cave LLP in St. Louis who works with company retirement plans.

With a 401(k) account, you generally don't pay tax on your contributions when you make them; instead, you pay tax on those contributions and any earnings when you withdraw the money from the account. (There are Roth 401(k) plans, in which you can deposit after-tax money and make tax-free withdrawals if you meet the holding requirements, but such plans have been around for only a few years.)

So, if you haven't paid any tax yet on the assets in your 401(k), you can't benefit from a loss, Ms. Van Fleet says. "It's supposed to be the beauty of the 401(k) -- you get earnings on a tax-free basis, and there's no tax until you take a distribution."

As you note, when a 401(k) participant with a loan loses his job and doesn't repay the loan, most plans consider the loan to be in default.

If you can't repay the loan, it would be considered ordinary income on which you would owe income tax, plus a 10% penalty if you are under age 59½, says Scott Holsopple , president of Smart401k LLC, in Overland Park, Kan., which advises 401(k) participants on investment strategy. Depending on the plan's rules and the circumstances surrounding the loan, you may owe taxes and penalties on the accrued interest as well. Mr. Holsopple suggests contacting your plan administrator to confirm the amount that it plans to include on your 1099 form, which is used to report such income to the Internal Revenue Service.

There is one bright spot: Even if you have a 401(k) loan that goes into default, it won't leave a bad mark on your credit, because you were borrowing from yourself, Mr. Holsopple says.

If you can pay off the loan, albeit tough to do when you lose your job, the loan won't go into default, and you won't owe the tax or penalty, he adds. But if you choose to pay off the loan, make sure you meet your plan's rules and deadlines for doing so.

Most plans allow a specific number of days from the last date of employment to repay an outstanding loan balance, says Janet Fossell , director of retirement and investor services for Principal Financial Group, a 401(k)-service provider in Des Moines, Iowa.