CARES Act and Loan Offset

[DJL]

Good afternoon. Just when I think I understand the CARES Act . . .

I cannot find a thread that discusses a loan offset under the following situation, though I was sure I had read one. Please advise me of the thread if one already exists.

• The participant had an outstanding loan and was up-to-date with his loan repayments at March 27, 2020.
• The Plan implemented the CRD and CARES Act loan provisions.   Loan repayments were suspended until January 1, 2021, at which time they are re-amortized and resumed.
• The participant is a qualified individual and stopped making loan payments when the Plan offered the loan suspension. 
• The Plan permits participants to continue making loan repayments after termination of employment.
• The Plan provides that a loan is in default if payment is not made the end of the maximum cure period
• On June 1, 2020, the participant, while still a qualified individual, terminated employment and took a CRD of all his vested account, except for the outstanding loan.  

When does his outstanding loan become a loan offset:

• June 1, 2020, when he took the CRD distribution?

             No--because the Plan permits him to continue making loan repayments after termination of employment. And, the IRS has suspended loan repayments until July 15, 2020.  OR

             Yes--because he took distribution.  He can treat the entire amount, including the loan offset, as a CRD distribution. (The sum of the CRD and loan offset are less than $100,000.)

• July 15, 2020, when he failed to resume loan repayments?

              No, because he is a qualified individual and has until January 1, 2021 to resume loan repayments.   OR

             Yes, because he had 30 days after termination of employment to repay the loan and he did not.  He can treat the entire amount, including the loan offset, as a CRD distribution.       

• January 1, 2021 if he fails to resume loan repayments?

            If so, this cannot be treated as a CRD because it occurs after December 31, 2020.           

Thanks for your help.

 

 

 

[Luke Bailey]

DJL, I'll vote for the "No's." There has to be a loan offset for there to be a distribution that can be treated as CRD. It sounds like that will not occur here until 2021. But perhaps not too bad an outcome? Participant would have until 2022 some time (2021 1040 due date, including extensions) to roll to IRA under the 2018 rules for rollovers of loan offsets. The rest of course qualifies for 3-year tax spread or 3-year rollover as CRD.

[DJL]

Thank you, Mr. Bailey. We were leaning in the direction that the offset would occur at January 1, 2021 and would not be a CRD distribution. Thank you for the reminder that he has until he files his 2021 tax return (including extension) to contribute the offset amount to his IRA.

[RatherBeGolfing]

If he has the cashflow or can come up with the funds to do it, couldn't he just make one loan payment now to pay the loan in full and then CRD the account balance? The requirement to make loan payments may be suspended, but nothing prohibits a participant from making loan payments voluntarily to avoid additional interest to accrue.

It may be worth it for him to borrow funds now and repay the loan after the distribution, just to get the CRD tax treatment rather than having the loan become taxable in 2021. 

[Lou S.]

Why wouldn't you treat the offset on June 1 when he terminated and took the rest of his balance? Would that have put him over the $100K CARES limit if you add in the loan balance? If it doesn't put him over the limit than treating it as an offset for CARES would seem like the best possible outcome for the participant as they would have up until 12/31/2022 to roll the CARES distribution back to an IRA. If you offset or worse default the loan in 2021 at some point as non-CARES the date will be earlier and might also be subject to the 10% penalty on early distribution.

If the loan plus distribution puts him over the $100K limit my analysis might be different.

 

[Luke Bailey]

1 hour ago, Lou S. said:

Why wouldn't you treat the offset on June 1 when he terminated and took the rest of his balance?

Lou S., you raise an interesting point. It probably depends on the terms of the loan as set forth in the loan policy, promissory note, etc. The OP says that the company applied the CARES Act extension, so my response was based on the conclusion that there is no default, and therefore no basis to offset, based on delinquent payments, until after 12/30/2020. But I guess the loan (through loan policy, etc.) might provide that the rest of the account is security for the loan, such that if it is distributed the loan still defaults, for a reason other than on account of nonpayment. Or if the loan says that it defaults on termination of employment (not the cessation of repayment because of termination of employment, but merely on termination of employment), then also you could have a default on June 1. In other words, the CARES Act loan rules are optional. Employer can adopt or not. If the loan after whatever amendment or policy has been adopted by the employer to implement CARES Act loan rules has defaulted for some reason OTHER than delinquent payments (of which there have been none), then you're probably right there would be a loan offset.

[DJL]

Thank you,  RatherBeGolfing. I understand that this participant does not have the funds to repay the outstanding loan balance. I agree that your suggested action would have been a good result for this participant.

Thank you, Lou S. and Mr. Bailey.  This loan program provides that the participant can continue to make loan repayments after termination of employment provided he/she starts 30 days after termination. If payments are not started within that timeframe, then the loan is defaulted and the offset applied. So, under that provision, the default  would occur July 1, 2020 and the loan offset applied. Since the Plan suspended loan repayments for each participant who certified as a qualified individual, we think that suspension overrides the loan program provision. (This is one of the very few plans we service that permits loan repayments after termination of employment.)

Most of our plans provide that the participant has 30 days after the date of termination of employment to either repay the loan or roll the loan over to another qualified plan (that is willing to accept it). If not done, then the loan is defaulted. In that case, we think that the default would occur 30 days after termination of employment, even if the plan suspended loan repayments under the CARES Act until January 1, 2021.

[Lou S.]

You could ask the participant if the intention was to offset the full account including loan when he took his distribution, that would clear up any confusion.

My guess is the participant has no thought about the loan balance anymore and is probably not expecting to start repaying it next January but that's just a hunch.

[RatherBeGolfing]

Just now, Lou S. said:

You could ask the participant if the intention was to offset the full account including loan when he took his distribution, that would clear up any confusion.

I just came back to say the same thing.

[Luke Bailey]

29 minutes ago, Lou S. said:

You could ask the participant if the intention was to offset the full account including loan when he took his distribution, that would clear up any confusion.

My guess is the participant has no thought about the loan balance anymore and is probably not expecting to start repaying it next January but that's just a hunch.

 

24 minutes ago, RatherBeGolfing said:

I just came back to say the same thing.

So the idea here is that the participant can ask for a distribution of his undefaulted loan balance? I guess that would work, although I've never seen that in practice or in a loan policy. It's essentially the same as allowing the individual participant to waive the CARES Act extension, which should be permissible, although in theory you would want to include that in your CARES Act admin memo and later amendment.

[Lou S.]

47 minutes ago, Luke Bailey said:

 

So the idea here is that the participant can ask for a distribution of his undefaulted loan balance? I guess that would work, although I've never seen that in practice or in a loan policy.

How often have you seen a terminated participant request a full distribution of his account and not seen any outstanding loan balance concurrently offset? Honestly this the first time I've ever heard it being done and it's probably due to the limitation of the CARES act distribution form that was used.

[DJL]

Lou S. -- you are correct. We did not contemplate this situation when we set up our CRD forms. 

I will suggest to the client that he contact the participant to give him the option to default in 2020.  We'll figure out how to document this if the participant elects to default in 2020.

[Luke Bailey]

3 hours ago, Lou S. said:

How often have you seen a terminated participant request a full distribution of his account and not seen any outstanding loan balance concurrently offset? Honestly this the first time I've ever heard it being done and it's probably due to the limitation of the CARES act distribution form that was used.

FYI, Lou S., the part of my answer above that follows your quote above was added an hour or so later. I was interrupted by call. I think my completed thought is more or less in line with yours.

[RatherBeGolfing]

7 hours ago, Luke Bailey said:

So the idea here is that the participant can ask for a distribution of his undefaulted loan balance?

I'm a bit curious as to the actual language, be it loan policy or plan document, that "permits" continued loan payments after termination as long as they are initiated within 30 days of termination.  Does participant have to make an election? Just a payment?  Is it an automatic 30 days, or does the participant elect to continue loan payments and in that case the first payment has to be made within 30 days of termination?  Does initiating a distribution trigger an offset in the absence of an election to continue loan payments after termination? Should it?

Ideally, this should be part of the distribution form.  I want a cash distribution, No I will not continue to make loan payments.

In the end, this is further complicated by the CARES suspension of loan payments.  Since participant elected a CRD of his account balance, I would give him the benefit of doubt and offset the loan

[Luke Bailey]

14 hours ago, RatherBeGolfing said:

Ideally, this should be part of the distribution form.  I want a cash distribution, No I will not continue to make loan payments.

In the end, this is further complicated by the CARES suspension of loan payments.  Since participant elected a CRD of his account balance, I would give him the benefit of doubt and offset the loan

Totally agree. That would be the way to do it, I think.

[DJL]

Thank you, Rather Be Golfing and Mr. Bailey.

Rather Be Golfing, thank you for the comment that the distribution form include acknowledgement that the loan repayments are being continued, even if a distribution is requested. We will look at adding this to the form with the plan restatement next year.

The language of the Plan's loan program provides that the 30-day suspension is automatic. : 

In the event that the participant terminates employment before the entire loan has been repaid, the collection of all loan repayments shall be suspended for a period of 30 days following the date of termination of employment.

At the end of the suspension period, the Trustee shall declare the outstanding principal sum of the loan plus any accrued interest to be in default, offset the participant’s account under the Trust by the defaulted amount, and treat the offset as a taxable distribution to the participant,  unless one of the following actions by the participant occurs prior to the expiration of the suspension period:

     The participant continues to make loan repayments in accordance with the loan note; or

     The participant repays the full outstanding principal sum of this Note plus any accrued interest; or

     The participant rolls over the participant's total vested interest in the Plan, including the outstanding principal of the loan, to another retirement plan that accepts such rollover.