Participant Loan after Rehire

[Susan S.]

Participant with a loan terminated and was rehired 6 weeks later.  Loan program specifies that the loan is in default upon termination, however, the loan has not yet been defaulted with the recordkeeper and there was no distribution of the remaining balance.  Is there any loophole that would allow the loan to be reinstated and the employee to continue repayment?  Does the Tax Cuts and Jobs Act allowing until the due date of the employee's tax return for repayment after termination come into play?

[Paul I]

This situation may be very nuanced, and you should read the plan very carefully as well as having a conversation with the recordkeeper about any tax reporting that will occur.

The IRS has FAQs that can be helpful in sorting out the possibilities.  https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-loans There are two technical terms - "default" and "offset" - that too often are used casually and interchangeably, and they are not the same.  You should get clarification on the plan provisions describing the treatment of the loan upon termination.  If it is truly defaulted, check to see if the date of default is specified in the plan document.  For example, if the loan is considered in default as of the end of the calendar quarter following the calendar quarter in which the last loan repayment was made, this default date may be later than the date the rehired  participant returned to active status (and restarted repayments and made up missed repayments).

If the plan truly says there was an immediate default, then IRS FAQ #6 says "[A] deemed distribution is treated as an actual distribution for purposes of determining the tax on the distribution, including any early distribution tax. A deemed distribution is not treated as an actual distribution for purposes of determining whether a plan satisfies the restrictions on in-service distributions applicable to certain plans. In addition, a deemed distribution is not eligible to be rolled over into an eligible retirement plan. "  That is pretty harsh news for a rehire to pay taxes on the loan and possibly pay an early withdrawal penalty.

Should the plan language supports characterizing the loan as being offset, the IRS FAQ #7 says it can be rolled over to an eligible retirement plan by "the due date, including extensions, for filing the Federal income tax return for the taxable year in which the offset occurs."  This is the rule you referred to in your last question.  If your plan allows for rollovers of loans into the plan and this loan was an offset (not a default), then the rehired participant could rollover the loan back into the plan.

Document, document, document all of the details surrounding how this ultimately is handled to protect the plan, to protect the participant and to memorialize the precedent it will set for future situations that may occur under these circumstances.

[Susan S.]

Paul, thank you for the clarification of terms.  It is a Relius document which states that the loan becomes due and payable upon termination of employment. The default date is as you mentioned, the following calendar quarter.  He was rehired before the default date so it does seem possible to let him make up the missed payments and continue repayment.

[Bri]

Can a distributed loan (offset of benefit, if his termination of employment triggers immediate distributability and the loan being due) be "rolled back in" indirectly within 60 days?  Thus making the loan "live" again?

(I know this doesn't seem typical, but what finer point do I miss when suggesting this?)

[Paul I]

Both of the above suggestions above are worth exploring.  Part of the consideration to declaring this particular loan as having been distributed and therefore having been offset is there was no distribution of the participant's remaining balance.

[Bird]

19 hours ago, Susan S. said:

It is a Relius document which states that the loan becomes due and payable upon termination of employment. The default date is as you mentioned, the following calendar quarter.  He was rehired before the default date so it does seem possible to let him make up the missed payments and continue repayment.

I wonder if the document drafter(s) actually contemplated that a loan might be paid back in those circumstances and set out deadlines for such repayment. If not (and I doubt it) I think it then goes to the end of the next quarter, so you can reinstate the loan as if it never defaulted. (And frankly, even if there was supposed to technically be an immediate default upon termination of employment, I would let this slide as long as the wheels on the recordkeeper's end have not started in motion. Plus the point about the rest of the account not being paid out is a good one; I think you'd almost have to have an offset at that point, if for no reason other than the hassle of dealing with the recordkeeper's computer system.)

[Luke Bailey]

On 11/16/2023 at 2:41 PM, Susan S. said:

The default date is as you mentioned, the following calendar quarter.  He was rehired before the default date so it does seem possible to let him make up the missed payments and continue repayment.

Would need to review plan language and know more facts, but might seem mandatory to let him make up missed payments and continue repayment to me. What if instead of terminating the employee had stopped loan payments, either revoked withholding or was garnished. But kept working. Plan would have allowed to reinstate loan before end of quarter following quarter of first missed payment.