401(k) Loan Rollover from one plan to next

[Guest Tdavid]

Hi there, I accidentally posted this to the Roth IRA and IRA forum instead of the 401(k) forum, maybe I will have better luck here:

So if you do rollover your loan from a prior plan to a new plan. Old plan allows transfer out and new plan will accept the loan note coming in.

How can you “catch-up” interest that you technically owed to the prior plan during the period where you couldn't make a payment to the old loan because you were terminated and they don't accept payments?

If there are three months that lapse between payments, and you are still within the original term cure period, wouldn’t you only be able to rollover your outstanding principal balance?

Example: 06/01/11 – Balance is $15,000. Interest rate is 1% monthly (for ease, $150).

Transfer to new company and set-up new loan

Principal balance as of 09/01 is $15,000 still. There has been missed interest for June, July and August.

You establish your loan and reamortize into new company 401(k) for a payment in September. Can the new company accept payments for missed interest that you owed to the prior plan? Or can they only establish $15,000 and charge 1% monthly going forward not to exceed original loan term length?

So technically, you missed $150 in interest to the prior company for June, July and August because you weren’t able to pay the prior company since you were terminated. Can that missed interest get incorporated into the new company payments? Or would they only be able to establish the $15,000 in principal as of 06/01/11 (the balance as of the last payment you made).

That 3 months of missed interest is a taxable distribution to you, you owed it to the prior company, but had no way to pay it to them because they won’t accept after termination partial loan repayments, only all or nothing payments were accepted there and the new company should only establish the principal?

Anyone know IRS regulations that talk about this? I have looked at Publication 575 and that doesn’t quite do it for me.

Thanks!

[ETA Consulting LLC]

You would first and foremost catch up on the "missed payments"; keeping in mind that the loan would typically become taxable at the end of the quarter after the quarter in which the first payment was missed. When it comes to calculating the additional interest on the "payments" that were delayed, those amounts would typically be negligible and would not constitute an unreasonable rate of return in their absence. Keep in mind that the interest accrual on the "outstanding loan balance" has already been incorporated into the original amortization schedule. Hence, when you delay on 3 payments of $150 each, your interest is only on the $450 at a rate of 1/12th of one percent on $150 for the first month, 1/12th of one percent on $300 for the second month, and 1/12th of one percent on $450 for the third month. You do this beyond 3 months, and your loan may already be taxable.

When you apply the monthly interest rate to the late payment only, you'll find that the amount of interest may be less than $1, because you are not applying that rate on the entire loan balance.

Good Luck!

[Guest Tdavid]

You would first and foremost catch up on the "missed payments"; keeping in mind that the loan would typically become taxable at the end of the quarter after the quarter in which the first payment was missed. When it comes to calculating the additional interest on the "payments" that were delayed, those amounts would typically be negligible and would not constitute an unreasonable rate of return in their absence. Keep in mind that the interest accrual on the "outstanding loan balance" has already been incorporated into the original amortization schedule. Hence, when you delay on 3 payments of $150 each, your interest is only on the $450 at a rate of 1/12th of one percent on $150 for the first month, 1/12th of one percent on $300 for the second month, and 1/12th of one percent on $450 for the third month. You do this beyond 3 months, and your loan may already be taxable.

When you apply the monthly interest rate to the late payment only, you'll find that the amount of interest may be less than $1, because you are not applying that rate on the entire loan balance.

Good Luck!

Hi, and thanks!

How do I catch up on missed payments though? The old plan won't accept new money from me unless I fully pay loan, and the new plan is only establishing the loan principal balance as of 06/01/11, $15,000. So as of 09/01/11, I technically still have the same $15,000 still due in principal.

06/01/11 - Balance is $15,000 (12 months loan, didn't make payments yet to old plan) ($992.79 in total lifetime interest per original amortization schedule) (monthly payments are $1332.73)

Payment Principal Interest Balance

Missed payment 1 $1,332.73 $1,182.73 $150.00 $13,817.27

Missed Payment 2 $1,332.73 $1,194.56 $138.17 $12,622.71

Missed Payment 3 $1,332.73 $1,206.50 $126.23 $11,416.21

Since the old plan didn't and won't take those payments, my loan principal is still $15,000 today, and on 09/01/11 my principal amount due is still the original $15,000. The old plan is going to 1099 me for $15,000 plus some interest missed until date of transfer from them to new plan.

Is the new plan setting it up wrong? The amortization schedule the new plan is giving me is to repay $15,000 over 9 months so I don't exceed original term, but total interest due now is $759.95 (instead of $992.79 from original terms) and my payment is $1751.

Should they be setting up $15,000 plus something so that I still payback the full $992.79 in interest, instead of just carrying over the principal from the prior plan? Can they accept interest that was "due" to the other plan? Should they accept a "catch-up" payment for my missed payments or interest? They seem to be insistent that setting it up to keep me "whole" and establishing an amount equal to the 1099 from the prior plan is something they can't do and are instead stating they can only set up my principal due, which is $15,000.

Since I am paying monthly, I will never be a quarter behind and shouldn't have to worry about exceeding my cure period, the loan will be paid off by original term date at a similar rate to before, it just appears that I am "missing" interest based on how it is being set up.

I guess at the end of the day, this just creates a ($992.79 - $759.95 = $232.84) taxable/penalizable event? Money that I technically "kept" that should have been repaid to my 401(k)?

Is there any IRS guidance on this that I can provide to the new plan to avoid this so they set it up so this doesn't happen?

Thanks again!

PS - I am using 1% per month, 12% per year interest, 12 month loan for ease and to highlight what is going on, that is not technically the rate, terms or the balance, but those were easier numbers to work with to highlight this situation, 12% would probably be considered excessive in today's world.

[K2retire]

The new plan should be setting it up using the same amortization schedule that was originally established. You just need to make a payment of $450 (or whatever the real numbers are) to get caught up and then resume the original payments.

[ETA Consulting LLC]

If it were me, and the account current cash balance in the plan were enough; here's what I would do:

Let's assume you have $100,000 in cash plus the current outstanding balance (i.e. $15,000) that is close to default:

1) Roll the $100K directly into the new plan.

2) Offset the $15,000 outstanding loan balance.

2a) Since this is a cash-less distribution, you have no withholding.

2b) The $15,000 loan offset (not a default) is eligible for rollover within 60 days.

3) Immediately take a $15,000 loan from the new plan under a new amortization schedule.

4) You now have cash available to roll over the $15,000 loan offset from the previous plan.

Good Luck!

[austin3515]

If it were me, I wouldn't worry about the three months interest. You're talking about $150 total (because 1% a month is extremely high). You get props for being so thorough, but in my opinion, with the loans, there is some wiggle room. So I find it very hard to believe that under audit, this would give you a problem...

Another option would be to have the new am scheudle at the new company be $15K plus the accrued interest. Also, make sure the new am scheudle is within the 5 year max, including the 3 month holiday.