Participant Loans 101

Maybe once upon a time I knew the answer to this question but I wanted to ask because it just came up as a question on a call.  We use the Corbel PT formatted Adoption Agreement and thre is an option for loans that basically says "all outstanding loans will become due and payable in their entirety upon severance of employment..."

Can someone please explain to me why I have been checking that box on all of  my plans for 20 years 😂  It doesn't change when it's taxalbe.  I assume it doesn't affect a loan offset? Or maybe that's it.

So you think that provision creates a balloon payment on the loan, and that is basically synonymous with a provision that says you cannot continue to repay your loan after you terminate. So the only reason to NOT have that provision is if the RK is repaying loans through ACH debits. 
 

this definitely sounds right!

Neither the Code nor the Treas Regs under 72(p) require that loan repayments be accelerated at termination of employment.  In addition, neither require that loan repayments must be permitted to after termination of employment.  Hence, the need for the election you have noted.

If the plan documents permit, loan repayments may continue to be made by the participants.  But, previously loan repayments would have been made via payroll reduction and they would no longer be able to done this way.  This would be require arrangements to be made with the recordkeeper for direct repayment via check or electronic payments such as ACH deduction from a participant’s bank account.  That said, in the past, most plans and/or their recordkeepers wouldn’t, couldn’t, or just didn’t want to, go through the administrative expense of working with individual terminated participants on repayment arrangements (just as @Lou S. is saying), so they would require immediate payment upon termination of employment.  Nowadays, recordkeepers are less reluctant (and plans seem to be neutral if the recordkeepers are okay with it).

This is simply a contractual restriction of the plan and/or recordkeeper—again, it is not a legal restriction.  However, the terms of the plan, loan policy documents or promissory notes must conform with the contractual loan restrictions.  If they don't, the plan sponsor could be violating the Truth in Lending Act.  Plan loans are loans (i.e., ERISA does not pre-empt the Truth in Lending Act rules that may be applicable).

Also, if this box is checked or unchecked, the choice will affect how this loan is treated and whether a loan offset can be used. 

If this alternative is checked in the adoption agreement, the plan and the recordkeeper would not and could not permit terminated employees to continue to pay off outstanding loans, and the loan would be immediately due and payable upon termination of employment.  Here, unless the outstanding loan balance is pre-paid (most plans or plan loan policies permit pre-payment) or paid within 90 days of termination, the outstanding loan balance would be reported as taxable income to the participant on a 1099-R. This is your loan offset.  Unless an exemption applies, the outstanding balance would be subject to the 10% early withdrawal penalty.  If the loan was in good standing on the termination of employment date, the participant could rollover the outstanding loan balance to another qualified plan or IRA (they would have to fund the rollover with their own funds) to avoid taxes and penalties, but the rollover would have to occur prior to the due date (including any extensions) for their tax return for the year of the loan offset.

If the due and payable alternative is not checked in the adoption agreement (and the plan loan policies and any applicable promissory notes do not provide for acceleration of repayment), the employer would be violating the terms of the plan and likely the Truth in Lending Act, if it does not permit them to continue repaying the loan after their termination of employment.  That is, the plan would not have a right to accelerate payments, to do a loan offset or to cause the loan to be defaulted (if they are willing and able to otherwise repay).

I'd say not so much 90 days, but as of the end of the cure period for the missed payment (of the entire due/payable outstanding balance) under the plan's policy, often the end of the following quarter.