Can you still make annual payment on an old, old loan or must they now

[Kathy]

Can you help? I am working with a client with a loan taken out in 1986, met the $50,000 limit (which was probably less than 1/2 his vested account balance at the time) secured by his principal residence. The loan papers required that he annually pay accrued interest for the year (at what was probably a reasonable rate at the time)and one twentyfifth of the principal - obviously the loan period is 25 years.

All of this met the terms of the plan document at the time. Now the plan has been amended (let's hope so, right??) to require payments at least quarterly. Are his old loan provisions grandfathered in? or must we make quarterly payments of principal and interest based on the amended document and more recent law changes but contrary to the agreement he signed originally???

[Kathy]

Ok, the real problem is that he is in default. No payments for several years. Now they're bringing me in to offer suggestions to fix. Ideas?

[bzorc]

I might start by bringing the loan current; that is, having the person make up all missing payments for the years in question, including unpaid interest.

Now the dilemma, in my opinion: Your original loan was before 1/1/1987, therefore, it did not have to be repaid quarterly. If payments had been made timely, this loan could have been repaid under its original terms, as it was allowed to be grandfathered (I am still administering loans taken in the early 80's like this). However, bringing the loan current can be considered "renegoiating" the loan, thus bringing it into quarterly payment status (the term can be longer, due to the principal residence provision). In my experience it has been left up to the plan administrator (usually the company) to decide which way to go. I have seen it both ways: Let the loan continue under the old terms, or a new loan agreement is drawn up, with appropriate at least quarterly payments of P&I. Also goes a lot to do you want to take a conservative or aggressive approach.

Hope this helps.

[Ron Snyder]

Go and read IRC Section 72(p) and its requirements and effective dates. Beware of the following:

1. Failure to foreclose on a loan may become a breach of fiduciary duty under ERISA.

2. Going into default on a loan causes the amount not repaid to be treated as taxable to the participant in the current year (although the funds, after repayment of the loan, may be distributed tax-free later).

3. Defaulting on payments causes the failure to foreclose to become a new extension of credit which would be subject to the newer rules.

4. The requirement of level amortization means that a failure to make such payments causes the loan balance to be taxable to the participant.

Read the Q&As under Regs. 1.402©-2, especially Example 6.