401(k) Loan Payroll Deduction Default

[KIP KRAUS]

Employee bumps another employee to prevent being laid off. As a result of the bump he loses $5 per hour. He has two out standing 401(k) loans, and now wants to stop having payroll deductions taken out to repay these loans. I know a loan will be deemed to be a distribution if not paid.

My questions are:

1. Can we allow him to stop making his payroll deductions to pay off these loans?

2. If we can and before the loan is defaulted, let’s say in 3 weeks he decides he wants to continue to make payments do we allow it? If we do does he have to make the back payments to catch up?

I say No, but who knows for sure.

I think this may have been discussed in the past, but I’m not sure.

[R. Butler]

There are several threads on whether payroll deduction for loan repayments can be rescinded. A majority say yes. I don't necessarily agree (primariy based on Advisory Opinion 96-01A), but it seems to be safer to allow the employee to rescind. We actually do advise clients to allow the employee to rescind.

The loan document (and the loan application) should define when a default occurs. If repayment isn't required via payroll deduction and the document provides for a cure period, the participant can bring the loan current during the cure period.

[KIP KRAUS]

Thanks RB.

I’m not sure exactly what a “Cure period” is, but our loan document seems to allow a person to restart their loan payments via payroll deduction before the loan defaults provided the accumulated interest from the stop date to the start date is paid immediately.

[R. Butler]

A cure period is really just a grace period.