48 MARCH / APRIL 2023 Question: My client had a loan in her former employer’s 401(k) plan. She just left to take a new job, but she can’t pay off the loan right now. What can she do? Answer: Plan loan administration can be complicated, but let’s try to make it a bit easier for your client. First of all, most plans will not permit former employees to continue regular loan payments because repayment through the former employer’s payroll system is normally required. The plan could accept a lump sum payoff of the loan, but this doesn’t happen very often. The client then has a choice: she can leave her assets in the plan, or she can request a distribution. If she does nothing, the loan will be considered in default once payments stop. If the loan isn’t repaid within the “cure” period – which ends after the calendar quarter following the quarter in which the default occurs – the former employer will typically treat the loan as a “deemed distribution.” This means that the plan administrator will generate an IRS Form 1099-R with a code “L.” This tells the IRS that the loan is taxable in that tax year and that the loan amount cannot be rolled over to an IRA or another plan. What about the second option? She can request a distribution. Assuming that the loan was in good standing when she left and that she takes the distribution within 12 months of leaving, your client now has more time to “repay” the loan (or even a portion of it) into an IRA. Here’s what’s changed: about two years ago, the IRS released final regulations on qualified plan loan offsets (QPLOs), which is what we’re talking about here. These new regulations have been effective since 2021. The old rules allowed former employees to roll PlanLoans What happens when employees leave? over plan loans for 60 days from the point that the employer “offset” the loan. In short, an offset means that the loan amount is taken off the plan’s books as a plan asset, and the loan is essentially forgiven. To be clear, the IRS may still consider the loan as a taxable distribution, but the loan will not have to be repaid to the plan. The problem for many of those with outstanding loans was, first, they might not even know when the loan was offset, and by the time they find out it would be too late. For example, if the employer offset the loan when the former employee requested a distribution mid-year, the employee may not be aware of the offset until Form 1099-R is sent out at the end of January. By that time, the 60-day rollover window is already closed. Second, even if the employee knows about the 60-day rollover rule, that’s typically a tight timeframe to pay off the loan. How much additional time do individuals have to repay a QPLO? In the final regulations, the IRS has clarified that an automatic six-month extension applies to the deadline by which a QPLO must be rolled over, provided that: % the taxpayer files a timely tax return, and % the taxpayer takes corrective action within the sixmonth period. If these requirements are met, taxpayers will normally have until October 15 of the year following the QPLO distribution to roll over that amount. Example: On June 1, 2022, your client has a $10,000 QPLO amount that is distributed from her plan. The automatic six-month extension applies if she timely files her tax return (by April 18, 2023), rolls over the QPLO amount and, if necessary, amends her tax return by Oct. 16, 2023, to reflect the rollover. Even though the QPLO rules now give clients more time to repay most outstanding plan loans, this doesn’t Jeff Aga Senior ERISA Consultant Ascensus ERISAcommunications @Ascensus.com Ascensus is an associate member of the Indiana Bankers Association. HUMAN RESOURCES
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