Terminated Participant has Loan Balance but not yet eligible for Withdrawal - Loan Default or Loan Offset?

Participant terminates in 2025. Plan provides termination distributions following the close of plan year in which termination occurs (and no partial withdrawals for termination distributions). Therefore termination distribution can occur in 2026.

Participant has a Participant Loan balance at termination.  Loan Programs states it is due and payable upon termination of service.

Q: Since the Participant is not yet eligible for a termination distribution, and further the plan does not permit partial withdrawals for Termination, is the loan balance a 2025 "deemed distribution" due to default (end of calendar quarter following quarter first payment is missed), which must be carried on the plan's books with (phantom) accrued interest until such time the Participant requests a termination distribution presumably in 2026? Or is it a 2025 "plan loan offset" since the Participant is terminated even though the Plan does not permit a termination withdrawal at this time, or partial withdrawals for terminated participants?  Concern with the latter: Treas. Reg. Section 1.72(p)-1, Q&A-13(b) provides that, in the event of a "plan loan offset", the amount of the account balance that is offset against the loan is an actual distribution for purposes of the Internal Revenue Code (IRC), not a deemed distribution under IRC Section 72(p). The concern being an actual distribution is not yet payable by the plan - it is not clear to me if this would (inadvertently) be an operational failure.

Thank you.

It seems like a poor design between the loan program and distribution conditions. Can the plan be amended to allow loans to be offset immediately on termination if not repaid in full? That would seem to solve a lot of potential issues as well allowing the participant Qualified Plan Loan Offset treatment for the loan instead of the less favorable Loan Default rules and the plan is going to going to have to issue a 1099-R one way or the other anyway.

Are you confirming there can not be a "Plan Loan Offset" distribution in 2025 (based on the fact pattern) even though the Participant is terminated (Treas. Reg. Section 1.72(p)-1, Q&A-13(a)(2)) because the plan does not otherwise provide a distribution at this time?  i.e. a plan loan offset is not an exception for terminated participants.

When a loan is considered offset and the consequences of how the loan offset is treated can get complicated.  I suggest reading through the examples in § 1.402(c)–2(g)(5)

I believe that if the Loan Policy says the loan will be due and payable upon termination of service, the rules in § 1.402(c)–2(g)(4) will govern and the loan will be offset upon termination of employment.  One complication to note is if the loan offset is within 12 months of the date of termination of employment, then it is a qualified loan offset which give the participant the ability to rollover the loan offset by the time the participant files their tax return for the year.  If the loan offset is not a qualified loan offset, then the rollover must be done within 60 days.

Warning - working straight through all 7 examples in the reg is hazardous to mental health.

20 hours ago, Paul I said:

I believe that if the Loan Policy says the loan will be due and payable upon termination of service, the rules in § 1.402(c)–2(g)(4) will govern and the loan will be offset upon termination of employment.  One complication to note is if the loan offset is within 12 months of the date of termination of employment, then it is a qualified loan offset which give the participant the ability to rollover the loan offset by the time the participant files their tax return for the year.  If the loan offset is not a qualified loan offset, then the rollover must be done within 60 days.

Warning - working straight through all 7 examples in the reg is hazardous to mental health.

Thank you, Paul. I agree with the above. My concern is whether there is a conflicting Plan Provision that absent its removal or modification (like Lou S suggested) effectively  prohibits it being a loan offset (though the employee is terminated) consequently causing it to be a loan default (and an eventual loan offset, not QLO, when his account is eventually withdrawn next year) - OR - because of the Loan Offset regs it is a Loan Offset (QLO if within 12 mos) irrespective of any plan termination distribution provisions to the contrary (e.g. delay of distributions until after plan year closes) regarding otherwise vested account sources.

It seems like you might have leeway for the Plan Administrator to make a reasonable judgment on conflicting plan provisions and treating the Loan as an offset would be the most reasonable in my opinion.