Taxable Interest Income on Loan Offset

[legort69]

Participant terminates with a 401k loan. The principal balance is $5,000. They have a default and offset. Plan allows grace period of 90 days to repay the loan in full. They do not pay off the loan during the grace period and they do not take a termination withdrawal. My question is whether you would report $5,000 on the 1099R or would the 1099R also include accrued interest income?

Appreciate it.

[Bird]

I can tell you that most, or at least some, recordkeepers will just default on the outstanding balance (no interest). If it's a plan where there is no (platform) recordkeeper, then we (third party administrator) will definitely just default on the principal balance if the loan default occurs in the same year as the last payment.

Probably the same result if the default occurs in the next year, although I might have to look it up. Something about deferring the default for a year makes my Protestant upbringing want to add a little bit of interest as a pound of flesh but I can't say for sure if we've done that, or done it consistently. I don't know if there is a "right" answer but maybe somebody else does.

[smermal]

Hi - I have a similar situation to the one described above and need some advice, please?

I'm actually the employee/participant in this case. I terminated employment with a 401k loan; mid-2015. The principal loan balance was about $8,000; total 401k balance roughly $40k. The plan apparently allowed a grace period of 90 days to repay the loan in full; so fall 2015. Unfortunately, I did not make payment during the grace period; I also took no further action whatsoever regarding the disposition of the 401k account in general, which is still held by the administrator. The administrator apparently recorded a default and deemed distribution (or loan offset; I'm not sure which) at the end of 90 days. Here are my two questions:

1) If inclined to do so, (and with consent of my prior employer), would the administrator be permitted by regulations to make an adjustment to their books at this point that would reverse the default, and allow me to pay off the loan properly (i.e., without incurring such a severe tax penalty from the unqualified distribution)? The reason I ask is because I feel their method of putting the loan in default to begin with was not proper, and constitutes an error for which I'm about to be penalized. There must be some method for correcting accounting mistakes, right?

(I did not receive any statement or correspondence whatsoever from the administrator notifying me that I was in default or about to be, nor providing payment information. There was no attempt whatsoever to request payment from me; they just summarily defaulted the account and, from my point of view, made a distribution without my consent. I would have paid if notified. Is this lack of communication common practice?)

Question 2) If #1 is not possible (to reverse the distribution), could I instead attribute the distribution to a different purpose at this point? E.g., I would pay the prior loan balance of $8k to the administrator, whereupon they would re-attribute the loan-offset-distribution to read as a distribution issued to me personally, for the purpose of paying un-reimbursed medical expenses. As it happens, I had enough medical expenses that I could have taken an $8k distribution to pay them without incurring the 10% IRS penalty. It's just poor planning on my part that I happened to pay those expenses from my checking account and the 401k loan got paid from my 401k. If I had paid the loan from my checking and the medical expenses from my 401k, I wouldn't be in this boat now...

Thanks in advance for any help!

[Bird]

They're probably going to say it's your responsibility to pay back the loan whether you got notification or not. There isn't much leeway in determining when a loan defaults; it's all very formulaic. The maximum allowance for defaulting is the end of the quarter following the date a payment was due and not paid, so if you had an outstanding payment due before 9/30 then the default sounds legitimate to me. That doesn't mean you couldn't raise a stink about lousy communications but I don't think it's going to get you very far, sorry.

[K2retire]

As it happens, I had enough medical expenses that I could have taken an $8k distribution to pay them without incurring the 10% IRS penalty. It's just poor planning on my part that I happened to pay those expenses from my checking account and the 401k loan got paid from my 401k. If I had paid the loan from my checking and the medical expenses from my 401k, I wouldn't be in this boat now...

Thanks in advance for any help!

That exception is only for distributions from IRAs, not 401(k)s. So it wouldn't have made a difference in your tax bill.

[smermal]

Thanks to all for your advice on this topic! I can see I'm probably beyond help at this point, but I'll continue raising the stink anyway and let you know what happens...

If anyone else has thoughts I'll welcome them - thanks in advance!