401(k) Loan Deem and Offset

[Guest Tdavid]

I have a question of best practices for accounting of loans and offset for deemed/defaulted loans.

If an active employee defaults on a loan (say they went on unpaid leave), and they are age 50 and have no distribution rights, then it is "deemed" and reported as taxable income if they don't make up by the cure period for missed payments.

A loan offset is created and accrues interest, unless the participant pays back the offset with interest to remove.

What if the Plan allows for in-service distributions from all sources of money at 59 1/2, and this person turns 59 1/2 after 9 years of carrying the offset? Should it be "removed"?

What if they terminate employment carrying an offset? Should the Plan remove the offset as soon as administratively feasible after term? Or wait until the person fully distributes their account?

I understand that removal of the offset with accrued interest doesn't create a new taxable event, in essence it is just to remove the principal "due" from when the loan deemed years earlier along with any accrued "phantom" interest "due", since the person did not have distribution rights when it was deemed, correct?

What about a person that is already 59 1/2 at the time they are defaulting on their loan? For example loan started at age 57, then at age 60 it defaults while actively employed. Should they have a deemed loan and offset? Or, since they have distribution rights, should it just be defaulted and no offset should carry?

I appreciate any insight, and references in IRS guidance if possible, this has proven to be difficult to ascertain exactly.

Thanks

[ETA Consulting LLC]

What if the Plan allows for in-service distributions from all sources of money at 59 1/2, and this person turns 59 1/2 after 9 years of carrying the offset? Should it be "removed"?

Sure. The participant has reached a distributable event under the plan.

What if they terminate employment carrying an offset? Should the Plan remove the offset as soon as administratively feasible after term? Or wait until the person fully distributes their account?

It should be offset immediately, since severance of employment is a 'distributable event'.

I understand that removal of the offset with accrued interest doesn't create a new taxable event, in essence it is just to remove the principal "due" from when the loan deemed years earlier along with any accrued "phantom" interest "due", since the person did not have distribution rights when it was deemed, correct?

Correct. The loan remains outstanding and restricts your ability to take additional loans.

What about a person that is already 59 1/2 at the time they are defaulting on their loan? For example loan started at age 57, then at age 60 it defaults while actively employed. Should they have a deemed loan and offset? Or, since they have distribution rights, should it just be defaulted and no offset should carry?

There would be no deemed distribution since the individual already has a distributable event. So, the loan would be offset immediately.

Good Luck!

[Bird]

I agree w/ETK, I think.

FWIW, in my world, the terminology is different...

a loan "offset" is what happens when a participant receives a distribution and has a loan that reduces the amount otherwise payable.

when a loan is deemed but stays on the books because there is not a distributable event, we call it a "prior deemed loan" or something like that (not an "offset")

[401king]

What does happen to the accrued interested once it is offset?

[ETA Consulting LLC]

What does happen to the accrued interested once it is offset?

Accrued interest is part of the outstanding balance. When the outstanding balance is offset, then there is no more loan.

Good Luck!

[ETA Consulting LLC]

I agree w/ETK, I think.

FWIW, in my world, the terminology is different...

a loan "offset" is what happens when a participant receives a distribution and has a loan that reduces the amount otherwise payable.

when a loan is deemed but stays on the books because there is not a distributable event, we call it a "prior deemed loan" or something like that (not an "offset")

Correct, it's all semantics.

A loan offset is an actual distribution.

An actual distribution cannot happen without a distriubutable event.

When is loan is defaulted, the loan becomes taxable (deemed distributed until there is a distributable event allowing an offset).

There is no such thing as a deemed distribution when there is a distributable event.

"Deemed distribution" is a method of immediate taxation since assets are not distributable under the terms of the plan.

I see it all as sematics.

Good Luck!

[Guest Tdavid]

I agree w/ETK, I think.

FWIW, in my world, the terminology is different...

a loan "offset" is what happens when a participant receives a distribution and has a loan that reduces the amount otherwise payable.

when a loan is deemed but stays on the books because there is not a distributable event, we call it a "prior deemed loan" or something like that (not an "offset")

Correct, it's all semantics.

A loan offset is an actual distribution.

An actual distribution cannot happen without a distriubutable event.

When is loan is defaulted, the loan becomes taxable (deemed distributed until there is a distributable event allowing an offset).

There is no such thing as a deemed distribution when there is a distributable event.

"Deemed distribution" is a method of immediate taxation since assets are not distributable under the terms of the plan.

I see it all as sematics.

Good Luck!

To recap what was said here, it sounds like it is better to think of the offset as the "distribution", and the deeming as a tax event.

Can you remove the offset a loan, in any case, prior to a participant having distribution rights?

Would a good practice be to set-up the accounting such that the offset is awaiting a change in status of the participant so it can be "removed" as soon as administratively feasible?

What if a loan is deemed 9 years ago, but the person doesn't have distribution rights and is still active, does it stay on the books (and count against their loan ability)?

If an offset occurs years after a loan is deemed, is a 1099 issued to a participant for the offset, so in that case they would receive a 1099 for the deem and a 1099 for the offset - but only have tax impact from the deem?

When should interest stop accruing on a loan offset? Should it stop with the original loan term? For example, 5 year loan, deem in year two and create and offset, interest accrues for 3 remaining years and stops? Or should it keep going until the participant has distribution rights and it can be removed?

Thanks