Suspension of 401k Loan payments

I was wondering of what advice/suggestions you might have for me. I have a 401k plan client with a participant that went on leave April of 2019. His 401k loan payments were suspended then. By rule, these payments can be suspended for up to a year (April 2020). Employee is still sick and still on leave. Client has NOT defaulted loan yet (yikes, should have been defaulted April 2020).

All the employees of this company were affected by COVID from a financial standpoint. Some were furloughed, others had hours cut, etc...  This employee in question will eventually come back.  Client and I are trying to see if it would be wise/legal to use the CARES Act loan payment suspension relief to give this participant another year (from April 2020 when original one year suspension was over) maybe until April 2021 to begin payments again vs defaulting loan.  Any suggestions/thoughts? Tax on defaulted loan will obviously be a burden..

I think you could get a COVID extension to 12/31/20 but I think payments would need to start in January 2021. 

I think he might be better off offsetting the loan in 2020 as COVID related. Participant would avoid 10% tax and could spread tax over 3 years or take in 2020. And could do a COVID repayment through 2022.

Thanks. This is the second exact suggestion for this idea. Happy Holidays.

Lou - are you allowed to offset the loan in this situation? I'm frankly confused on this issue. So two situations:

A. Plan allows Covid distributions. Is this considered a "distributable event" if you default on the loan, such that you are allowed to offset?

B. Plan does not permit Covid distributions. Same question, can you offset defaulted loan?

P.S. - I suppose I should add that I'm assuming there has been no OTHER distributable event that would allow the offset...

I was assuming the Plan allows for COVID withdrawals especially since OP said loan payments were further suspended under CARES Act, if it doesn't you are probably correct.

But if it does allow for COVID withdrawals I think you can do the Loan Offset as described, as long a participant elects it. If you're not comfortable with a direct offset you could do a 2 step process that accomplished the same thing - take a COVID distribution for the balance of the loan and immediately pay off the outstanding loan.

Just to clarify, if he did terminate and so had a loan offset on or before 12/30/2020, then it could be Covid distribution no matter what plan says. And a deemed distribution will not work for Covid period, right? So you're saying if the plan permitted Covid distributions he could elect to take a distribution of his loan?

21 hours ago, Luke Bailey said:

Just to clarify, if he did terminate and so had a loan offset on or before 12/30/2020, then it could be Covid distribution no matter what plan says.

That is my understanding. If the plan allows for a loan offset and the participant terminates on or before 12/30/2020, the participant could claim the loan offset distribution as a COVID.

21 hours ago, Luke Bailey said:

And a deemed distribution will not work for Covid period, right?

Again, this is my understanding. The "deemed" distribution would not otherwise be a distributable event.

22 hours ago, Luke Bailey said:

So you're saying if the plan permitted Covid distributions he could elect to take a distribution of his loan?

Not a distribution of the loan, but a distribution of the portion of the account balance equal to the loan balance, which distribution would be on account of a COVID event, followed by immediate repayment of the loan balance.

53 minutes ago, FORMER ESQ. said:

Not a distribution of the loan, but a distribution of the portion of the account balance equal to the loan balance, which distribution would be on account of a COVID event, followed by immediate repayment of the loan balance.

OK. I guess that would work for sure, Former E. But do you think they could distribute the loan?

42 minutes ago, Luke Bailey said:

I guess that would work for sure, Former E. But do you think they could distribute the loan?

Luke, are you asking whether or not the participant (who is not in default on a loan) elect to "distribute" his loan balance in 2020 to take advantage of the favorable COVID tax treatment? If so, I think the answer is no. I do not see how anything in the statute or IRS guidance  supports that position. What is your take?

On ‎12‎/‎18‎/‎2020 at 7:51 PM, FORMER ESQ. said:

Luke, are you asking whether or not the participant (who is not in default on a loan) elect to "distribute" his loan balance in 2020 to take advantage of the favorable COVID tax treatment? If so, I think the answer is no. I do not see how anything in the statute or IRS guidance  supports that position. What is your take?

FORMER ESQ., why not? You have a 401(k), it allows COVID distributions, you can take from any of your accounts. There was nothing in the legislation that said it had to be pro rata across all your accounts, and also when you take a distribution some plans permit you to say which investments you want to liquidate for the distribution. So seems to me you probably could ask for your loan to be distributed, if the plan permitted. Nothing says you can do it, but nothing says you can't either.

2 hours ago, Luke Bailey said:

FORMER ESQ., why not? You have a 401(k), it allows COVID distributions, you can take from any of your accounts. There was nothing in the legislation that said it had to be pro rata across all your accounts, and also when you take a distribution some plans permit you to say which investments you want to liquidate for the distribution. So seems to me you probably could ask for your loan to be distributed, if the plan permitted. Nothing says you can do it, but nothing says you can't either.

Access to cash. The whole rationale for the COVID distribution option is to give participants much needed access to cash. I don't see how a loan distribution does that, unless access to cash means potential lower payment of taxes in the future. That is possible. But access to cash now seems to be the the underlying intent, which is the reason for the temporary loan suspensions. 

20 hours ago, FORMER ESQ. said:

Access to cash. The whole rationale for the COVID distribution option is to give participants much needed access to cash. I don't see how a loan distribution does that, unless access to cash means potential lower payment of taxes in the future. That is possible. But access to cash now seems to be the the underlying intent, which is the reason for the temporary loan suspensions.

I agree that access to cash was the main intent, but I think it is irrelevant. The law says what it says. And anyway, the overriding rationale was to help participants affected negatively by C-19. The economic effects of C-19 will be continuing. If you could distribute just the loan as a C-19 distribution, then the participant would get out of the 10% tax (assuming he or she is not 59-1/2), would no longer need to make payments on the loan, and could roll money into an IRA over the next three years to wipe out the tax, if things improve. If it's a small enough loan that the participant could pay the tax, or would go on installment agreement with IRS, it might help him or her.

51 minutes ago, Luke Bailey said:

I agree that access to cash was the main intent, but I think it is irrelevant. The law says what it says. And anyway, the overriding rationale was to help participants affected negatively by C-19. The economic effects of C-19 will be continuing. If you could distribute just the loan as a C-19 distribution, then the participant would get out of the 10% tax (assuming he or she is not 59-1/2), would no longer need to make payments on the loan, and could roll money into an IRA over the next three years to wipe out the tax, if things improve. If it's a small enough loan that the participant could pay the tax, or would go on installment agreement with IRS, it might help him or her.

I read the main legislative intent as a temporary stop gap for a liquidity crunch during 2020. Much narrower reading than you. To provide cash relief during 2020 (their main concern), among other things, they allowed for the temporary suspension of loan payments during 2020. If they were focused on the continuing economic pain post 2020, they could have extended the COVID-19 distribution relief to all of 2021 or 2022 as well. Or they could have extended loan suspensions through all of 2021 and 2022 as well. 

Your scenario described above does not address the cash crunch they face in 2020, but future cash flow. And if future cash flow (post 2020) was as important component to the legislation, they could have extended the loan and distribution relief to 2021 and beyond.  

17 hours ago, FORMER ESQ. said:

 

I read the main legislative intent as a temporary stop gap for a liquidity crunch during 2020. Much narrower reading than you. To provide cash relief during 2020 (their main concern), among other things, they allowed for the temporary suspension of loan payments during 2020. If they were focused on the continuing economic pain post 2020, they could have extended the COVID-19 distribution relief to all of 2021 or 2022 as well. Or they could have extended loan suspensions through all of 2021 and 2022 as well. 

Your scenario described above does not address the cash crunch they face in 2020, but future cash flow. And if future cash flow (post 2020) was as important component to the legislation, they could have extended the loan and distribution relief to 2021 and beyond.  

 

 

 

 

FORMER ESQ., for good or ill current federal jurisprudence favors "textualism" over search for statutory intent. All I'm saying.

If the loan is on extension then is it in default? Did the CARES Act. specifically prohibit a loan offset as valid CARES Act. withdrawal? I think those are the questions. I believe the answer to the firsts is clear that the loan is not in default prior to 12/31/2020 if it was properly suspended under CARES.

The second question is a bit more gray and treating the loan offset as part of a CARES Act distribution may or may not be an aggressive position. I think taking a CARES Act distribution and then repaying the loan balance is not aggressive at all but requires a few more steps and cooperation of the participant to repay the loan with the proceeds of the CARES Act. distribution.

22 hours ago, Luke Bailey said:

FORMER ESQ., for good or ill current federal jurisprudence favors "textualism" over search for statutory intent. All I'm saying.

Luke, when I left big law more than eight years ago to become a businessman overseas, what I missed the most about practicing law was trying to make the "argument."  I enjoyed our back and forth on this topic, and do not think your position is unreasonable. There is a logical purity to it. The participant's loan note (which is secured by the account balance) is an asset. It should be treated like any other asset and should be eligible for a COVID-19 distribution.  But with all of the relief specifically provided with respect to loans, I would hesitate and at least contact the IRS on a no-names basis to see what they think.  Anyway, do they still do that nowadays? I recall specific contacts for specific Code Sections, etc... It has been a while.  

OK, Former ESQ. I agree. I think we have gotten as close to the bottom of this as we can. Even if I am right (and I think I am), the solution is so "custom" that no one, or close to no one, will use it. Agree on that. Lou S.'s solution is more practical, I just wanted to press the intellectual case that it could be done the other way if for some reason you wanted to do that.