Advertising Material

Advertising Material


The Loan Zone: Curing Late Payments on Loans From Qualified Employer Retirement Plans

If participant loans are permitted by the terms of an employer’s qualified retirement plan, such loans must comply with restrictions outlined in the tax code. Failure to meet those restrictions can result in the loan being treated as a taxable distribution to the participant.

One restriction is the requirement that any participant loan from a qualified employer retirement plan be repaid in substantially level payments over the term of the loan, with installment payments due at least quarterly. Additionally, with one exception relating to home loans, participant loans must be repaid in full within five years. 

Terms of a participant loan, including repayment terms, must be set out in an enforceable agreement. A participant’s failure to make an installment payment under the terms of the loan agreement can result in a deemed distribution at the close of the next calendar quarter.

The good news is that the plan may allow a cure period (up to the last day of the calendar quarter following the quarter in which the installment payment was due).

Recently, the IRS issued Advice Memorandum 201736022,[i] which gives the following two examples of how the cure period may be properly used to make up missed installment payments. 

In each example, the loan agreement states that the installment payments are due at the end of each month, with full repayment within five years. In both cases, the plan allows a participant to cure a late loan payment by the end of the calendar quarter following the quarter in which the payment was due.[ii] 

Example 1: Applying Future Installments to Missed Payments

Facts:

  • The participant misses installment payments due March 31, 2019 and April 30, 2019.
  • The participant makes installment payments on May 31, 2019 (applied to the missed March 31, 2019 payment) and June 30, 2019 (applied to the missed April 30, 2019 payment).
  • On July 31, 2019, the participant makes a payment equal to three installment payments (applied to the missed May 31, 2019 and June 30, 2019 payments, as well as the installment payment due July 31, 2019).

Why this works:

Under the cure period, the missed March 31, 2019 installment must be repaid by the end of the following quarter, June 30, 2019. It was repaid May 31, 2019, within the cure period. The missed April 30, 2019 installment must be paid by the end of the following quarter, September 30, 2019. It was repaid within the cure period on June 30, 2019.

The missed May 31, 2019 and June 30, 2019 installment payments must be repaid by the end of the following quarter, September 30, 2019. They were repaid on July 31, 2019, within the cure period. The July 31, 2019 installment was paid on time.

Example 2: Refinancing

Facts:

  • The participant misses the October 31, 2019, November 30, 2019 and December 31, 2019 installment payments.
  • On January 15, 2020, the participant refinances the loan and replaces it with a new loan equal to the outstanding balance of the original loan, including the three missed installment payments.
  • Under the terms of the new loan, monthly installments are still due at end of each month, and the new loan must still be paid in full by the end of the term of the original loan.

Why this works:

Under the cure period, the three missed installment payments (October 31, 2019, November 30, 2019, and December 31, 2019) must be repaid by the end of the following quarter, March 31, 2020.

The new loan pays off the entire outstanding balance of the original loan (including the three missed payments) within the cure period, on January 15, 2020.

[i] A word of caution: IRS Advice Memoranda may not be used or cited as precedent. Plan administrators should always use caution to comply with IRS statutes and regulations and precedential guidance.

[ii] Both examples assume the loan (and the refinanced loan in Example 2) otherwise meets the requirements of 26 U.S.C. § 72(p) and 26 C.F.R. § 1.72(p)-1, which describe the full panoply of restrictions on participant loans.