QUESTION: If a 401(k) plan loan ends upon termination of employment, or a participant’s account balance is reduced to repay a loan after a default, can the resulting plan loan offset amounts be rolled over? If so, how does that work?
ANSWER: Plan loans can trigger two kinds of taxable distribution: deemed distributions and plan loan offsets. A deemed distribution is a taxable event that occurs (a) when certain loan requirements are not met, e.g., if the loan’s repayment term is too long, the level amortization requirement is not met, or the loan is not evidenced by a sufficient legally enforceable agreement; or (b) upon a default if at that time the participant could not obtain a distribution (e.g., because the borrower is an active employee under age 59 ½). Although they result in taxable income, deemed distributions are not actual distributions and are not eligible rollover distributions (see our Checkpoint Question of the Week).
By comparison, a plan loan offset is an actual distribution that occurs when a participant’s accrued benefit is reduced to repay a loan in accordance with the loan’s terms. That can occur if a participant defaults at a time when the participant could obtain a distribution (e.g., after attaining age 59 ½), or the participant requests a distribution and the loan, by its terms, must be treated as in default if it is not immediately repaid. (Plans sometimes allow participants to take a distribution of their unpaid loan, and roll over the loan note (see our Checkpoint Question of the Week).)
A participant can avoid taxation on the plan loan offset amount by rolling it over to an eligible retirement plan that accepts rollovers (which could be an IRA or another tax-qualified plan). The funds for that rollover will have to come from the participant’s other assets, however, since the plan loan offset simply extinguishes the loan liability—it does not result in the participant receiving any new funds. If the participant has not spent the loan proceeds, those funds could be used. If those funds have already been spent, the participant must find some other way to fund the rollover contribution.
Typically, plan loan offset rollovers must be accomplished by contributing funds to the eligible retirement plan within 60 days after receipt of the distribution, which in the case of a plan loan offset would be the date of the offset. Effective January 1, 2018, however, the Tax Cuts and Jobs Act changed the deadline for loan offset distributions due to plan termination or severance from employment. Under that exception, the rollover can be made until the due date, including extensions, for filing the participant’s federal income tax return for the taxable year in which the offset occurs.
For more information, see EBIA’s 401(k) Plans manual at Sections XIV.D (“Sixty-Day Rollover Distributions”) and XVI.F (“Consequences of Nonpayment: Default and Taxable Distributions”).
Contributing Editors: EBIA Staff.