Inactive 401(k) participant deferring plan loans WITHOUT making loan payments or taking distributions.

[Guest Richard Plant]

How long can an inactive participant defer 401k / profit sharing plan loans without making payments or receiving taxable distributions?

Will the loan keep accruing interest until the loan (principal and interest) reaches the market value of the account?

Participant left employer in 1999 with a 19K loan balance (4 loans total).

2 participant loans on the Money Purchase Plan*

2 participant loans on the Savings Plan*

Participant was not in default at termination as loan payments were deducted from pay.

* PDF (partial plan documents attached for both plans)

Participant has never made a payment since 1999.

Participant has never received a distribution from plan.

Participant has never received cummunication from plan indicating a loan default (deemed or offset).

Its reasonable to expect that a distributable event should have occured after termination - but nothing happened.

To this very day, the participant's 401k statement only shows the principal loan balance of 19k (and does not indicate that interest rate nor the amount of accrued interest). Participant never saw interest accruing on the 401(k) statement and therefore did not take action to pay off 19k loan.

During a phone call today, the participant discovered that the loan interest has been accruing at 8.25% and has accumulated to over $8,000 of interest for a total of $27K due).

The total account value is worth 36K (with 27K representing loan principal and accrued interest).

Participant is upset that the quarterly 401(k) statements failed to disclose this growing debt.

Savings_MMP_Plans.pdf

[Tom Poje]

a couple of questions:

1.was the loan part of the general investment of the plan, or was the loan an individual investment of the employee.

2. once the person quit, was there not a distributable event under the terms of the plan?

[FundeK]

It is very difficult to answer this question correctly without reading the plan document/loan policy. I am going to answer based on a standard loan policy for a 401(k)/PS plan that requires the loan to be paid in full at termination. I am also assuming the loan is an individual investment and all payments were current prior to termination.

How long can an inactive participant defer 401k / profit sharing plan loans without making payments or receiving taxable distributions?

Inactive = Terminated. I would allow the participant 90 days to repay the loan after termination. Once the 90 days have passed, and no payoff has been submitted, I would offset the loan, which is a taxable distribution. It is always a good idea to allow a reasonable time period after termination to repay the loan. (Reasonable is always subject to individual interpretation.)

Will the loan keep accruing interest until the loan (principal and interest) reaches the market value of the account?

A deemed loan would accrue interest until it is offset, or paid off. I would not continue to accrue interest on a loan that should have been offset, but was not due to adminstrative error.

Participant left employer in 1999 with a 19K loan balance (4 loans total).

Participant has never made a payment since 1999.

Participant has never received a distribution from plan.

Just because the participant did not receive a distribution does not mean the loan didn't go into default. A loan is defaulted (either deemed or offset) when the participant fails to make payments.

How would I correct this?

I would offset the loan now. Issue a 1099 for the principal balance and interest that accrued through the date the loan should have been offset (90 days from the termination date). You should not accrue interest through today's date. The participant would still have the option to rollover the funds if they could come up with the cash to make the deposit.

OF course, all of my responses are my interpretation, based on a loan policy that requires full payment upon termination.

[Guest Richard Plant]

I updated the initial question and attached a partial copy of the plan documents. Any comments?