Loan defaults still treated as asset on balance sheet?

[Fielding Mellish]

A 401(k) plan allows for plan loans. A participant defaults on the loan (fails to make the required payments), so the loan is treated as a deemed distribution.

Why does the financial statement continue to carry the deemed distribution as an "asset"?

[Tom Poje]

one reason for keeping track of the loan (and accruing interest) is if the individual requests another loan. you must reduce the amount of any future loans by this amount as it is still considered an outstanding loan.

[Fielding Mellish]

one reason for keeping track of the loan (and accruing interest) is if the individual requests another loan. you must reduce the amount of any future loans by this amount as it is still considered an outstanding loan.

Thanks for your reply.

I understanding keeping track of the loan, but why continue to carry it as an "asset" on the balance sheet?

In the Plan, you can't get another loan if you're in default. I should have mentioned that before, sorry.

[Belgarath]

It would depend upon whether the loan can be "offset" or not. If it is just a deemed distribution and there has been no "distributable event" then the loan can't be "offset." Technically it is still an asset of the plan, and technically the obligation to repay still remains. (In real life, it is rarely repaid, and the PA rarely attempts to collect it) But, if repaid, you will then have non-taxable basis which must be separately tracked.

If it can be "offset" then you could no longer carry it on a separate line, as the account balance would then be reduced.

[Guest Sieve]

Bel --

Do you agree that a deemed distirbution will prevent an individual from taking another plan loan if the plan only permitts one loan at a time (unless the deemed loan is refinanced as part of the new loan)?

If the plan permits 2 loans, then must the first loan be repaid--or refinanced--in order for a 2nd loan to be taken?

[Tom Poje]

personally, it does seem kind of goofy. you don't include the amount on the 5500 becasue it shows up as a distribution.

however, it is still an 'asset' and counts toward top-heavy.

The ERISA Outline Book gives a blurb in Chapter 7 IX E.2.d. (2006 edition) talking about how the IRS ruled there was a prohibited transaction when the trustee failed to charge interest on a defaulted loan (even though that interest doesn't make a bit of difference once the person is eligible for an actual distribution)

[Belgarath]

Hi Sieve - well, my answer is the dreaded "it depends." See the following - from 1.72(p)-1:

Q–19: If there is a deemed distribution under section 72(p), is the interest that accrues thereafter on the amount of the deemed distribution an indirect loan for income tax purposes and what effect does the deemed distribution have on subsequent loans?

A–19: (a) General rule. Except as provided in paragraph (b) of this Q&A–19, a deemed distribution of a loan is treated as a distribution for purposes of section 72. Therefore, a loan that is deemed to be distributed under section 72(p) ceases to be an outstanding loan for purposes of section 72, and the interest that accrues thereafter under the plan on the amount deemed distributed is disregarded for purposes of applying section 72 to the participant or the beneficiary. Even though interest continues to accrue on the outstanding loan (and is taken into account for purposes of determining the tax treatment of any subsequent loan in accordance with paragraph (b) of this Q&A–19), this additional interest is not treated as an additional loan (and thus, does not result in an additional deemed distribution) for purposes of section 72(p). However, a loan that is deemed distributed under section 72(p) is not considered distributed for all purposes of the Internal Revenue Code. See Q&A–11 through Q&A–16 of this section.

(b) Effect on subsequent loans —(1) Application of section 72(p)(2)(A). A loan that is deemed distributed under section 72(p) (including interest accruing thereafter) and that has not been repaid (such as by a plan loan offset) is considered outstanding for purposes of applying section 72(p)(2)(A) to determine the maximum amount of any subsequent loan to the participant or beneficiary.

(2) Additional security for subsequent loans. If a loan is deemed distributed to a participant or beneficiary under section 72(p) and has not been repaid (such as by a plan loan offset), then no payment made thereafter to the participant or beneficiary is treated as a loan for purposes of section 72(p)(2) unless the loan otherwise satisfies section 72(p)(2) and this section and either of the following conditions is satisfied:

(i) There is an arrangement among the plan, the participant or beneficiary, and the employer, enforceable under applicable law, under which repayments will be made by payroll withholding. For this purpose, an arrangement will not fail to be enforceable merely because a party has the right to revoke the arrangement prospectively.

(ii) The plan receives adequate security from the participant or beneficiary that is in addition to the participant's or beneficiary's accrued benefit under the plan.

(3) Condition no longer satisfied. If, following a deemed distribution that has not been repaid, a payment is made to a participant or beneficiary that satisfies the conditions in paragraph (b)(2) of this Q&A–19 for treatment as a plan loan and, subsequently, before repayment of the second loan, the conditions in paragraph (b)(2) of this Q&A–19 are no longer satisfied with respect to the second loan (for example, if the loan recipient revokes consent to payroll withholding), the amount then outstanding on the second loan is treated as a deemed distribution under section 72(p).