Loan Defaults 101

[thepensionmaven]

Participant takes loan on his vested account balance, terminates several months later, having only repaid 2 quarterly installments.

Pardon a senior moment, but I believe the total account balance is the investment fund balance plus the outstanding loan balance.

Participant wants to take his money, default on the loan.  Loan default would be outstanding balance as of the date of last payment plus interest through the term of the loan.

He is eligible to rollover the investment portion of his account and the loan balance plus accrued interest is taxable.

Two 1099Rs, one for the rollover, one for the loan default.

Participant over 59 ½.

Is the loan default subject to 20% withholding?

[PensionPro]

yes withholding applies to account balance including o/s loan

[Doghouse]

As I recall, if he rolls everything but the loan, there is no withholding.

[Tom Poje]

there is an example in the ERISA Outline book that indicates no withholding if the remaining balance is rolled over Part E.3.b.3

though I would never remember any of this stuff in regards to loans.

[thepensionmaven]

Thanks, Tom.

[Kevin C]

If you are looking for a cite, it's
 

Quote

 

31.3405(c)-1

Q-11: Are there special rules for applying the 20-percent withholding requirement to employer securities and a plan loan offset amount distributed in an eligible rollover distribution?

A-11: Yes. The maximum amount to be withheld on any designated distribution (including any eligible rollover distribution) under section 3405(c) must not exceed the sum of the cash and the fair market value of property (excluding employer securities) received in the distribution. The amount of the sum is determined without regard to whether any portion of the cash or property is a designated distribution or an eligible rollover distribution. For purposes of this rule, any plan loan offset amount, as defined in §1.402(c)-2, Q&A-9 of this chapter, is treated in the same manner as employer securities. Thus, although employer securities and plan loan offset amounts must be included in the amount that is multiplied by 20-percent, the total amount required to be withheld for an eligible rollover distribution is limited to the sum of the cash and the fair market value of property received by the distributee, excluding any amount of the distribution that is a plan loan offset amount or that is distributed in the form of employer securities. For example, if the only portion of an eligible rollover distribution that is not paid in a direct rollover consists of employer securities or a plan loan offset amount, withholding is not required. In addition, if a distribution consists solely of employer securities and cash (not in excess of $200) in lieu of fractional shares, no amount is required to be withheld as income tax from the distribution under section 3405 (including section 3405(c) and this section). For purposes of section 3405 and this section, employer securities means securities of the employer corporation within the meaning of section 402(e)(4)(E)(ii).

 

 

[Luke Bailey]

He can also roll over the loan balance if he can come up with the cash by his Form 1040 filing deadline next year for this year, of course.

[WCC]

On 9/13/2018 at 2:43 PM, Luke Bailey said:

He can also roll over the loan balance if he can come up with the cash by his Form 1040 filing deadline next year for this year, of course.

Hi - can you help me understand the logistics of the Tax Reform change allowing payment of loans before the due date of the 1040? I have reviewed the new rule but am trying to figure out how it will actually work. I have not been able to find details of the logistics. Let me give an example:

Participant terminates today with an outstanding loan. The outstanding loan balance is $10,000 and cash with the record keeper is $50,000. Participant completes a distribution form to roll the $50,000 to an IRA. Participant is subject to the early withdrawal penalty as no exception applies. Record keeper will prepare a 1099R with a code M1 for the loan balance. Participant does not have $10,000 in cash ready to pay back the loan. Participant wants to pay installments before the deadline of the Form 1040. 

Questions: If the participant wants to pay the loan back, how does this get sorted out? Do the loan payments before the due date of the 1040 happen with the IRA or with the 401(k) plan? If the loan payment happens with the IRA provider, the record keeper will send the 1099R since they won't know of the participants repayment to an IRA. How does the IRA custodian know what the loan amount was and what to accept as repayment of the loan vs contributions (has anyone see this happen with an IRA custodian)? Does the participant then prove at the time of filing the 1040 that loan payments were made to an IRA? Is that proved similar to the 60 day rollover transaction?

Thanks for your help.

[Luke Bailey]

Let's say the loan offset distribution occurs today:

* The $50k cash is rolled. No issue.

* No withholding on the $10k not immediately rolled. See 1.402(c)-2, Q&A-9(b) and (c).

* So no withholding at all on distribution.

* Even under old law, he/she had 60 days from today, so until about Xmas 2018, to come up with some amount from $1 to $10k and deposit that cash into IRA as the rollover of the loan offset. To the extent he/she did so, only the excess, if any, of $10k over amount rolled over would be 2018 gross income subject to 10% penalty.

* The only thing new law changes about preceding bullet is that he/she now has until April 15, 2019, or later, until extended due date, if goes on extension for 1040, to roll the money over. Whatever gets rolled over, he/she indicates that amount on 1040, just as before.

* If he/she knows for sure going to roll over some, but not all, of the $10k, then he/she may want to pay estimated tax or, probably better, adjust 2018 withholding with new employer on W-4.

[WCC]

Thanks, very helpful!