401(k) Rollover Question

[Guest Benmark]

I understand that if a participant receives a distribution from his or her 401(k) plan then changes his/her mind and instead wants a rollover, that person would have 60 days from the date of distribution to roll that money into an IRA (or other qualified plan), PLUS any amounts that may have been withheld for taxes, to not incur any taxes on the distribution or penalties. A similar question has come up regarding loan defaults.

Situation: Participant terminated employment. Upon termination, he had an outstanding loan amount. Through some confusion, the date to make restitution of his outstanding loan came and went. (Participant believed he had more time to make the deposit, which was substantial.) Recordkeeper put the loan into default. Now participant is upset because of the confusion over his payoff date (which was incorrectly given to him by one of the customer service reps of the Recordkeeper). Based on administrative error and detrimental reliance, we will probably make an exception and allow the participant to repay the loan by the given due date (and undo the loan default). However, I was thinking that this whole thing could be much simpler.

Couldn't we just keep the default and instruct the participant to roll over that money into an IRA within 60 days of the loan going into default? Wouldn't that action have the same impact as if the guy would have paid it to the plan?

I think yes, but wanted to get your expert opinions. Thanks in advance for your help (and sorry for the long message!).

[QDROphile]

The IRA can't hold the loan. It would be a prohibited transaction that would kill the IRA. The loan could be rolled over to a qualified plan, but only as a direct rollover (and not really even then, but the IRS says it can be done, so who cares what the right answer is?).

[Guest Benmark]

Thanks for the quick answer. I wasn't referring to the IRA holding the loan. Our plan would put the loan into default and report this to the government. However, my understanding was that, since the loan came from the participant's 401(k) assets to begin with, he could take the amount of the loan that was put in default and write a check for that amount (or a sub-portion of that amount) and deposit it into an IRA within 60 days of the loan going into default. If he did this, it is (in effect) the same as if he had paid off the loan to the plan. Right?

[QDROphile]

If the loan is not already distributed, why can't the individual write the check to the plan in the amount of the loan balance? Then there would be no loan in default and the distribution would be conventional. When you are not dealing with cash, I recall something like a rollover has to be the asset distributed or the proceeds of that asset. If that is the rule, I wonder if the independent check in the amount of the distributed loan would be "proceeds" delivered to the IRA.

[Guest Sieve]

Benmark --

If there has been no distribution, all you have is a "deemed" distributed loan resulting from the default (requiring the issuance of a 1099-R). The remaining portion of the account balance is then treated separately upon its eventual distribution.

A deemed distributed loan can never be truly distributed in-kind (i.e., as a loan), because it ceases to exist when deemed distributed. A deemed distributed loan therefore cannot be rolled over (Treas. Reg. Sections 1.72(p)-1, Q&A-12 & 1.402©-2, Q&A-4(d)). On the other hand, a plan loan offset--i.e., when a loan is distributed when it is not in default--is an actual distribution (Treas. Reg. Section 1.72(p)-1, Q&A-13(b)), and presumably can be rolled over.

I'd extend the payment period due to the miscommunication errors, allowing the loan to be repaid or actually distributed as a plan loan offset (rather than be defaulted) & thus have, as QDROphile says, a conventional distribution. Otherwise, if the loan is treated as distributed due to default, there is nothing that can be done with it because it has not been--and cannot be--actually distributed.

[Bird]

Benmark, I think Sieve is correct. It sounds like the other plan money was not yet distributed, so you had a loan default, and not a loan offset. A loan default is a taxable event, but the plan still holds the loan, so there was no actual distribution to roll over.

Now, if he did get paid his other money, you might consider re-classifying the events so that the loan was offset, not defaulted, then I think what you suggest might work.