Cashing loan check immediately after firing

A client of mine had an employee who requested a loan which was approved for $20,000 The employee received and cashed the check a couple of days after being fired. It is unlikely that the employee could afford to repay the loan to the plan, but, if he could afford it, is there a period of time during which he could repay the loan?

The loan policy should specify if terminated employees can repay loans and on what terms. It should also specify when the loan defaults - typically the grace period is the end of the quarter following a missed payment.

(and if loans are automatically due/payable upon termination of employment, you're looking directly at 6/30 even if the guy tried to make some partial repayments now thinking following the schedule buys him into a future quarter.)

The amount of the loan is deducted from his defined contribution plan account when he requests a distribution.  There is no logic in requiring the participant to pay back the loan only to add it back to his account at the time of distribution.  

16 hours ago, fmsinc said:

The amount of the loan is deducted from his defined contribution plan account when he requests a distribution.  There is no logic in requiring the participant to pay back the loan only to add it back to his account at the time of distribution.  

Well, you can't make him pay it back at all, but you can make him pay it back within a certain time frame if he wants to avoid a default. Which he might want to do in order to avoid the taxable event.

I think this (paying back to the plan to avoid a taxable event so the entire amount could be rolled over) was more important before the QPLO rules. Since the participant terminated employment, it should be treated as a Qualified Plan Loan Offset (QPLO), and the employee has until extended tax filing deadline for the year of the offset to use other funds as a rollover. So, seems to me that there's nothing much to be gained from a tax perspective by depositing those funds back to the plan to repay the loan. Maybe easier administratively somehow by having it all directly rolled over in one lump sum, I suppose.

Maybe I'm missing something here...

2 hours ago, Belgarath said:

Maybe I'm missing something here...

No, you're right about the end result. I do think it might work out better, cleaner to pay back to the plan if funds are available.

A loan from a Participant's defined contribution plan is not a "loan" at all.  It's a misnomer.  When he takes a loan from his plan account he is borrowing his own money.  When he pays it back he is paying it back to himself and is paying interest to himself.  He is only disadvantaged by the fact that the amount of the loan is not part of his account for the purposes or being credited/debited with gains, losses and investment experience, dividends and interest, etc.  

It is like taking $20 out of the cookie jar in the kitchen and putting $21 back in the jar next week.   

Thinking of a 401(k) "loan" like you think about a loan from a bank is not helpful and leads to this sort of discussion thread. 

If, (i) the guy doesn't pay it back within the required time, and if (ii) he had not previously taken a distribution or rolled over his account balance to an IRA or other eligible account (in which events you would have reduced such distribution or rollover by the amount of the loan remaining due), then issue a 1099-R and be done with it. 

Please don't tell me how his money is not in a segregated account for his sole benefit but is part of the entire 401(k) so that you are really borrowing from the entire plan account.  That may be technically true but is meaningless.  His periodic statement of benefits defines his share balance, outstanding "loans", and payments made. 

fmsinc, from the perspective of a loan being an asset in a participant's account, much of what you say is true.

From the perspective of how the loan is treated when reported on a 1099R, there can be a big difference.  The loan 1099R could be coded as an 'L' or 'M' and paired with at least 5 other distribution codes.  The number of combinations of distribution codes leads to discussion threads like this one.

Then there are the plan accounting issues when a loan is defaulted before the participant terminates, becomes taxable and the participant resumes repayments.  This creates tax basis in the participant's account which also is reported on a 1099R.

While in many plans the loan is strictly earmarked to the participant and the participant's account, there are plans where the loans general assets of the plan.  In this case, the loan is a plan level investment and not a participant level investment.  The loan rules have to accommodate this scenario.

When dealing with the treatment of loans, simple often is not so simple.