Past Due Loans

Key Takeaway

Retirement plans may offer participant loan programs within the parameters of the Tax Code and the plan’s loan policy. The loan policy describes loan limitations and repayment processes. Plan sponsors must ensure timely loan payments are made and report defaulted loans to the IRS as taxable distributions. Following are some common issues.

REVIEWS ARE IMPORTANT

If the participant fails to make up missed payments during the “cure period” the plan must report the unpaid balance to the IRS as a defaulted loan and taxable distribution.

LOAN MONITORING

Alerus recommends that you review your loans on a regular basis. We provide past due status reports via Employer Plan Access. To review loans, including past due loans:

  • Log in to Employer Plan Access and select your plan
  • Under Manage My Plan, select Manage Loans
  • Under the Loan Browse tab, click on the Status drop-down menu, select Past Due, and click Go
  • The Past Due Loans report will show loans that are 32 days or more late.

REMINDERS

Alerus will notify you quarterly of any loans that may be nearing the end of the IRS permitted cure period.

CURE PERIOD

The cure period is a grace period during which participants may make up missed payments and avoid a defaulted loan. Each plan determines the cure period as part of its loan policy. Most plan sponsors have adopted the loan policy template provided by Alerus. That policy includes the following:

  • Current employees: The plan uses the maximum IRS Cure Period. The grace period begins on the date of the missed payment and ends on the last day of the following calendar quarter. For example, if Bob misses a payment due February 2, he has until June 30 to bring the payment current. If he fails to do so, the plan reports the outstanding loan balance as a distribution.
  • Former employees: If a participant terminates employment the outstanding loan balance may be due within 60 days. If your plan’s loan policy does not have language requiring the loan to be defaulted due to termination, the cure period grace period applies.

DELAYING A DEFAULT LOAN

Loan policies may permit participants to forego payments during approved leaves of absence or military leave. For non-military leave, the delay can be for no more than 12 months. More liberal rules apply to military leave. Also, your loan policy may provide participants with a period of 60 days in which to repay a loan in full following employment termination. You should review your loan policy for specific rules covering these issues.

Complete and submit a Loan Default Delay Form to Plan Access under file type Compliance Information. To ensure proper documentation of the delayed defaulted loans, Alerus requires completion of the Loan Default Delay Form for each quarter a request is made to delay the default.

APPROVED LEAVE OF ABSENCE

An approved leave of absence is generally medical, maternity, paternity, FMLA, or military leave. The IRS has not provided guidance regarding whether layoffs caused by seasonal employment or employer-initiated temporary shutdowns are approved leaves of absence. In order to avoid default questions, some plan sponsors require loan repayments during layoffs.

“CURING” PAST DUE PAYMENTS

There are three options for curing the default, provided the action occurs during the cure period:

  1. 1

    Make a lump sum payment to bring the loan current.

  2. 2

    Increase payments so the loan is current by the end of the cure period.

  3. 3

    Refinance the loan, if the plan’s loan policy permits.

Refinancing will pay off the old loan and begin a new loan. However, to avoid exceeding the IRS loan limitations, the new loan must not have a final payment date later than the original loan. In other words, the refinanced loan should merely re-amortize the amount due over the remaining loan period.

OTHER OPTIONS

Additional options depend upon whether you or the employee caused the failure to timely pay the loan.

  1. 1

    If the employee failed to pay, then the loan balance should be reported to the IRS as a taxable distribution as of the last day of the cure period.

  2. 2

    If the employer’s actions caused the repayment failure (for example, a payroll withholding error), then the IRS permits a correction using its self-correction program (SCP). The correction procedure involves bringing the loan current by either a single-sum repayment, re-amortization of the outstanding loan balance, or a combination of the two.

Note: SCP has additional rules. Not every failed repayment situation qualifies. Please contact the Alerus administrator assigned to your plan for further information.

REPORTING A TAXABLE DISTRIBUTION

  • Active participants: Form 1099-R is issued and the loan remains on the recordkeeping and trust system until the participant terminates. This is in accordance with IRS rules and is called a “deemed distribution.”
  • Terminated participants: Form 1099-R is issued and the loan is treated as a distribution and removed from the participant’s account balance even if the participant chooses to defer distribution of the mutual fund investments.