Disabled Participant Unable to Repay loan

[emmetttrudy]

A participant has an outstanding loan and because of a disability they have moved from full time employment to part time. Their part time compensation is not sufficient to make the loan repayments. What are the options? If she stops making payments and the loan is defaulted would she be eligible for the exception to the 10% early withdrawal penalty?

[ETA Consulting LLC]

Check the loan terms in the document. There is some relief to the participant under the 72(p) regs to all them to delay payments when their compensation is reduced to amounts that make it impossible to repay the loan. I'm stating the rule loosely, but the terms of the plan should define the relief.

As for the 10% exemption, it's strictly 72(m)(7)... Inability to engage in ANY substantial gainful activity. Some documents provide a disability benefit based on a different definition (for which participant is best qualified through training or experience), but that doesn't fly with the 10% exemption. If you can work, then no exemption.

Ultimately, when the 1099-R is coded, you will only face an issue if you actually have to prove it to the IRS. Ultimately, that is the standard, whether you can prove your disability to the IRS. If they see ongoing w-2, the that would normally imply that you are engaging in substantial gainful activity; you may try to argue it's not substantial, but I would be on that argument.

Good Luck!

[ESOP Guy]

I believe you should check the promissory note also. If you are using one of the ones from a service often times they are written with the payroll deduction is part of the note. The note is a contract so a person may not always be able to stop the payment. Some are written such the only way to stop the payment is to stop being paid, i.e. terminate.

I feel for this person. However, sometimes the law just isn’t kind. However, the plan has to follow the law anyway.