Loa repayments not completed in 5 years

[Jakyasar]

Owner only plan.

Loan was not paid off in 5 years (5 years ended 12/31/2025) and 3 left.

Is there any self correction?

Otherwise, what needs to be done?

Never dealt with this before.

Thanks

[fmsinc]

It's not really a loan like you would make from a bank.  The Participant has borrowed his own money, pays himself back, pays interest to himself.  Just because the source is the entire plan account doesn't change that reality.

Make a taxable distribution to the Participant  and the "loan" will be paid off in full

.  

[Jakyasar]

Will the taxation be for 2025 or 2026? I agree with being a distributable event.

[David D]

If an installment payment is missed and not paid by the end of the calendar quarter following the quarter of the missed payment (the cure period), the entire remaining loan balance plus accrued interest is deemed distributed.

Even though the amount is taxed as a distribution, the loan stays active. You must keep paying it back, and those ongoing repayments create "after-tax basis" so you aren't taxed twice on those amounts when actual future distributions occur.

[ConnieStorer]

Hi Jakyasar,

Keep in mind that the CARES Act allowed additional time for repayment.  You may want to look at the original loan paperwork. 

[Artie M]

Dont believe SECURE 2.0 permits the plan to disregard the expiration of the five-year statutory repayment period.   Under your facts, the loan should ber a deemed distribution after the applicable cure period as stated above.  And finally the participant may still repay the debt, but repayment does not erase the deemed distribution.

[fmsinc]

DAVID D.

 

Can you cite me some authority for your comment?    Thanks, 

 

[David D]

HI fmsinc,

Which comment?  Does this help    https://www.irs.gov/retirement-plans/fixing-common-plan-mistakes-plan-loan-failures-and-deemed-distributions

[Artie M]

SECURE Act expanded who could correct it didn't expand how a §72(p) loan may be corrected once the statutory five-year repayment period has expired.  See §305 of SECURE 2.0 implemented on an interim basis by Notice 2023-43.

Rev. Proc. 2021-30 expressly says that its tax-free correction methods for §72(p) failures are not available once the maximum repayment period under §72(p)(2)(B) has expired.

§72(p)(2) and Reb. §1.72(p)-1, Q&AQ-10, for cure period.  See also the loan snapshot at https://www.irs.gov/retirement-plans/issue-snapshot-plan-loan-cure-period

The authority for paying back the loan is that the loan is still live though deemed distribution.  This is stated in Reg. §1.72(p)-1, Q&A21 that specifically asks "Is a participant’s tax basis under the plan increased if the participant repays the loan after a deemed distribution?” and responds yes.  NOte the deemed distribution is a distribution only for certain tax purposes.  It does not extinguish the note or the loan obligation.  Paying off the loan satisfies the contractual debt owed to the plan.  See also Q&A19.  Interest keeps running on the loan until paid.

[fmsinc]

I admit to being smothered by all of this.  I don't understand how the Participant can FAIL to make full repayment in 5 years.  Logic, (in my world), would be that at the end of 5 years the balance due would automatically become a taxable distribution - and done. 

Does the Plan Administrator have any duty to notify the Participant that the payment is coming due, or that the abyss is in sight, or of the adverse financial  consequences what are on the horizon?

My interest in this matter is that I handle divorce mediation and the preparation of QDROs (and similar documents transferring retirement benefits between divorcing parties). The parties are ALWAYS in financial distress.  The borrow from their 401(k) plans, they take hardship distributions, they even quit their jobs so they can take post termination distributions in excess of the 50%/$50,000 loan limits.  They explore the possibility of SECURE alternatives what would allow immediate in-service annuity payouts. 

They want to pay for the kid's braces, pay off credit card balances, pre-pay college expenses, cover legal fees and court costs.