Accrued Interest on Participant Loan

[Guest Ann]

Participant has a loan outstanding at time of termination. Payments were behind but not to the point of default, i.e. not 90 days behind. Participant requests distribution of his account upon his termination. Is interest accrued on the loan until distribution actually occurs? If so, is the amount of cash distributed to the participant reduced by the accrued interest on the loan or is the distribution amount grossed up by the amount of the accrued interest? The Plan states that a participant loan is a self-directed investment.

[Guest Dook]

I have seen two approaches: Consider that interest accrues only through the date of termination or, that interest accrues through the earlier of, the end of the quarter in which termination occurs or the distribution date. Either approach requires that the accrued interest be included in the participant's account balance and reported for distribution purposes.

[This message has been edited by Dook (edited 10-20-98).]

[Guest Ann]

Does this mean that the amount of the distribution to the participant is increased by the amount of the accrued interest on the loan. I read somewhere that if the loan is a participant directed investment, that it will be considered a "wash" for accounting purposes. Does this mean that the interest is accrued on the loan, but that the gross amount distributed to the terminated participant is still the same net value as though the interest had not accrued on the loan, i.e. his net cash distribution is decreased by the amount of accrued interest on the loan. Is this correct? example: participant has a $1,000 loan which accrues interest of $10. Prior to interest accrual the participant's plan account balance totaled $10,000 including the loan balance of $1,000. Will the distribution show $1,010 distributed as a loan balance and a net distribution of cash as $8,990 less withholding on the entire amount of $10,000? or will the gross distribution be $10,010 with the $1,010 being the loan amount and still have $9,000 cash distributed less withholding on $10,010. Do you reduce the total participant cash account balance by the amount of the accrued interest when distributing? Is the accrued interest taxable to the participant?

[Guest Dook]

Any accrued interest adds to the account balance. So a $10,000 cash balance, plus a loan of $1,000, plus accrued interest of $100 makes a total account balance of $11,100. The total amount is taxable to the participant at distribution and subject to 20% withholding.

[Guest D_NITSCHE]

I agree with Dook ; if you view the loan as an investment that provides a return equal to the loan's rate then his answer makes sense. Of course,the repayments are reinvested along with other plan assets but the base loan invested is providing a return at the loan rate.