Loans

[Guest SEV]

Client wants to adopt procedures for handling unpaid leaves of absence for future 401k loans that will avoid some of the administrative issues they’ve had in the past. They propose adopting procedures giving employees returning from unpaid LOAs the choice of (1) re-amortizing the loan to ensure full repayment by the original end-date of the loan (thus increasing the amount of each payment via payroll deduction) or (2) resuming payment in the same amount as prior to the leave, with a balloon repayment of the unpaid balance at the end of the loan term. In my experience, nearly all employees would elect choice #2. This appears to be permissible under Reg. sec. 1.72(p)-1, Q/A9. However, I haven’t heard of plans incorporating #2 into their procedures and wonder if I am missing something. (What about the fact that the employer knows most employees will not make the balloon payment at the end, resulting in an automatic deemed distribution? Does that somehow taint the loan from the end of the LOA?) Does anyone have experience with this approach?

[Guest Sieve]

I have not had experience with loans in an unpaid leave of absence scenario, but your choice #2 is not permissible. The loan still must be levelly amortized from the time payments begin again until the loan is paid off--no balloon payment is permitted.

The loan does not have to be repaid by the end of its original term. It must be repaid by the end of the maximum term permitted at the time the loan originated (5 years), so long as the installments payments after the leave are not reduced below what they were originally. (Treas. Reg. Sections 1.72(p)-1, Q&A-9(a) & ©.) So, a less-than-5 year loan can be extended, and/or the loan payments can increase, but the payments cannot decrease.

[rcline46]

Balloon payments are not permitted under 72(p) - get a PDF version of law and or regs and search for balloon.

[Guest SEV]

See Reg. sec. 1.72(p)-1, Q/A9 (d) Example 1 [ 5-year loan; participant takes LOA, returns; (i) loan is reamortized with increased installments to end of original 5-year term; (ii) "Alternatively, section 72(p)(2) would be satisfied if the participant continued the monthly installments of $825 [ the original amount] after resuming active employment and on June 30, 2008 [end of original 5-year loan term] repaid the full balance remaining due."

[Guest Sieve]

I stand corrected. Would have been nice if I'd read the last sentence of the example! Learn something every day.

Of course, among other things, in that case the plan may have to be amended to permit re-amortization and, perhaps, to permit loan repayments to be other than through payroll deduction (which many plans require).

Since both examples in Q&A-9 relate to a 5-year loan, I wonder if a shorter loan (such as 3 years) could be ballooned or if the loan would have to be adjusted to permit level amortization. It is interesting to note that the reg. itself (except in the examples) does not discuss the balloon possibility (although you probably will tell me that I missed that somewhere, too).

I'd say "don't ask" about future payment plans. If installment payment is by payroll deduction, then I don't think it's tainted by any presumptions you might make about potential future balloon non-payment, or even by specific statements the borrower makes about his/her intentions with regard to future ballooon payment/non-payment.