Active Post NRA Participant Wants Loan Balance "Distributed" as a Loan Offset

[cheersmate]

401K Plan permits In-Service withdrawals beginning age 59-1/2; partials of at least $1000. 

Participant is past Normal Retirement Age, actively employed, and has a Participant Loan with a substantial balance; let's say it is $40,000.

Business has been flat this year and making the loan payments is increasingly more difficult. Last payment was end of November 2024. Next due is end of December (monthly payroll). There is a strong chance no wages will be paid for December.

Participant would like the Loan Balance "distributed" this year, as the tax implications would be minimal due to extremely low income, per the CPA. There is hope that things will improve next year but not certain how quickly it may turn around or to what extent if any it will turn around.

If the December 2024 loan payment is not satisfied, a default would occur and the correction period would run to 3/31/2025 per Loan Program.

Can the Participant request in essence a (permitted) partial withdrawal equal to the Loan Balance, or in other words request a Loan Offset and no additional cash distribution at this time (i.e. in service)? And if yes, then Form 1099-R would be Code 7 but not Code M (since not termination of service or plan, not QPLO), zero taxes withheld?

Thank you.

[Bri]

I would think this would be okay when viewed as an in-service distribution rather than a loan default.  He can request a 40,000 distribution of his account since he's past 59½ and the specific investment being "liquidated" to pay the benefit is the loan note itself.  But I'd have to think about the withholding obligation there.....

[ESOP Guy]

I think zero taxes withheld is correct.  You withhold the lessor of 20% of the distribution or cash distributed when there is a mix of cash and in kind assets. 

 

[CuseFan]

Does the plan document support in-kind distributions? I think that would be a requirement and then note it applies to everyone all the time.

Otherwise, I don't think he can simply have his loan distributed/offset in total without also taking a total distribution. He could accomplish his objective doing that and directly rolling over his non-loan assets, having the loan offset taxable piece but no taxes withheld. If he really wanted to keep his other money in the plan then he could roll back. Even if plan had in-kind distributions are you all comfortable with someone just deciding they don't want to repay so they take as a distribution? 

Another option, but has a cash cost, would be a $50,000 taxable distribution, $10,000 withholding and $40,000 net cash used to pay off loan. This results in $10k more as a taxable event with all of such extra being withheld and then much being recovered later via assumed tax refund.

[Artie M]

To me as plan administrator, you only have 2 questions:  (1) Under the terms of the Plan, does he have a right to a withdrawal/distribution? (2) Under the terms of the plan, loan program and promissory note, does he have a right to prepay the loan?  Sounds like the answer to those two questions are yes.  If so, you handle the distribution and the loan payoff as you normally would.  The liquidation of investments, tax consequences, etc. are his problems to figure out.

Just my thought so DO NOT take my ramblings as advice...  

[cheersmate]

Thank you everyone!

The Plan does permit permit in-service, in-kind for loan balances, and partial distributions at age 59.5.

To sum it up:

Participant is going to request an In-Service Withdrawal equal to the Loan Balance, using the proceeds to payoff (offset) the loan in its entirety. There will be no remaining funds for tax withholding purposes. Form 1099-R will be Code 7 (but no M). Agreed?

[Artie M]

Hmmm... seems like you should be withholding 20%.  Technically, the distribution qualifies as an eligible rollover distribution and is not being rolled over to a plan as a direct rollover.  As such, there is mandatory 20% withholding.  It would bea Code 7 with no M (normal distribution' no loan offset because the plan is not terminating and the distribution is not due to severance of employment).

 

Just my thoughts so DO NOT take my ramblings as advice...