Loan Default Question

[Guest 401KTPA]

Here is the question.

A person terms 9/2002. According to the client after 3 months their 2 loans are in default. The person is not taking a final distribution at this time but leaving the money in the plan.

Is it correct to process the loan defaults now and issue a 1099r. (Just a note, the account balances are reduced by the loan amounts at the time they are issued.) Then when they get their next statement of account the loans will show as a 0.00 balance. Then at some point in the future they can take their final distribution whenever they want and the loans will not show or be taxed later.

My problem is I have someone telling me that the new regs state that " even if you default the loan now the balance remains as part of the assets until such time as the particiapnt is terminated. In addition if the participant decides that he/she would like to pay the loan off at a later date he must be given the opportunity to do so. If the participant decides to take out another loan at a later date then this loan must be staisfied before doing so and must be considered as part of the highest outstanding loan balance in the last 12 months."

How can you give participants an indefinite time to pay off a defaulted loan.

Lastly, when do the new regs go into effect.

Thanks

[jaemmons]

Once the grace period has expired (ie.-end of the quarter following quarter last payment was received) and the participant has not made any loan repayments, the loan becomes a deemed distribution and becomes a taxable event to the participant. A 1099R is issued for the year the grace period expires.

If your plan document offsets the loan when a distribution event occurs, then the loan would be offset, in your case, against their account balance if they are able to take immediate distributions after termination of employment. The statement that the individual told you is accurate, but is not applicable here unless your plan document does not allow immediate payment of plan benefits.

The allowance for repayment is part of the loan policy may only be extended for the duration of the grace period outlined in the final regs. (which apply to loans made on or after January 1, 2004).

[austin3515]

When someone defaults you get a "deemed distribution." The loan is still there an must be paid off until a distributable event occurs.

Once a dsitributable event occurs, a "loan offset" can occur. For most plans, termination is a distributable event, although some will require one to five breaks in service prior to a distributable event. In 401(k) Plans, attaining age 59 1/2 is also a distributable event (i.e., termination not required) Once there is a loan offset, the loan is officially gone.

I provided this elaboration to clarify the difference between loan offsets and deemed distributions, a concept which many readers may not understand. It is clear that the people who posted the two above posts understand this very well...