Using COVID dist to pay off loan

Does anything prohibit a participant from taking a legitimate COVID distribution and using  part of it to pay off an existing (non-COVID) loan?

Thanks in advance.

No, that's fine. Once they take the distribution, they can do anything they want with it.

So here is a scenario.  Participant has suspended their loan under the CARES Act.  Participant is still working, does not have a distribution option under the Plan (other than CRD).

The participant has already informed their employer that they do not intend to start payroll deductions in January and want the loan to default as a deemed distribution, taxable with penalties for 2021.  Also, the plan permits only 1 outstanding loan with no refinance option (other then the CARES Act reamortization in January), so the participant would be unable to take another loan until the pay off the deemed loan.

Would the participant be better off taking a CRD and paying off the loan now.  They could spread the tax out, eliminate the 10% penalty, and avoid the deemed loan scenario?  Plus they could pay the CRD back over 3 years if they were so inclined?

Thanks.

That's probably a better question for their tax accountant (which I understand  they probably don't have) but I'd have a hard time seeing where the CARES, Act option you lay out wouldn't be a better option than the 2021 default. The only scenario I can think of where taking the default in 2021 looks better is they expect to be in a lower marginal tax rate in 2021, that is they expect a big drop in income between 2020 and 2021.

46 minutes ago, Gilmore said:

Would the participant be better off taking a CRD and paying off the loan now.  They could spread the tax out, eliminate the 10% penalty, and avoid the deemed loan scenario?  Plus they could pay the CRD back over 3 years if they were so inclined?

Gilmore, you've answered your own question, I think.

Thanks guys.  I've learned sometimes it best to ask what you think is obvious because it's easy to overlook something.