QUESTION: We have several 401(k) plan participants who have been called to active military service and would like to suspend their plan loan repayments during their military leave. Do the rules for suspending loan repayments during a regular leave of absence apply to military leave?
ANSWER: The rules for suspending loan repayments during a military leave of absence are broader and more flexible than for a regular leave of absence. For a regular leave, the maximum suspension period is one year and the entire loan must be repaid within the maximum permissible term (five years, for nonprincipal-residence loans). For a military leave, however, your 401(k) plan may permit suspension of loan repayments for the entire period of the military leave even if that period exceeds one year, and the term of the loan may be extended to the maximum permissible term of the loan plus the period of military leave. But it is important to remember that interest on the outstanding loan would continue to accrue during the military leave suspension period.
Example. Julie took out a three-year loan on February 1, 2017, and was called to active military service for two years, beginning on October 11, 2017. Your plan can suspend her loan repayments during her entire two-year military leave. If she had not been on military leave, her last loan repayment would have been due on January 31, 2020. But, because she will be on military leave, the term of the loan may be extended to its maximum permissible term (i.e., five years, if the loan is a nonprincipal-residence loan) plus her period of military leave (i.e., two years). With this extension, her last loan repayment would be due on January 31, 2024.
When a participant returns from military service, loan repayments must resume and must be made in substantially level payments. Because interest continues to accrue during military leave, however, the participant’s post-leave loan balance will be greater than the pre-leave balance. The plan may permit the participant either to resume paying the same dollar amount as before with a “balloon” payment of the balance due at the end of the loan term or to reamortize the balance due over the remaining loan term with payment amounts not less than those required under the original loan.
Also note that the Servicemembers Civil Relief Act (SCRA) provides that the interest rate on loans (including 401(k) plan loans) during a period of military service cannot be more than 6% per year and imposes a criminal penalty for knowing violations of the interest-rate limit. While SCRA requires servicemembers to give the plan notice of their service orders, due to the criminal penalties, plan sponsors may want to consider imposing the 6% interest limit on any outstanding plan loan of a servicemember on military leave.
For more information, see EBIA’s 401(k) Plans manual at Sections XVI.B.4 (“Level Amortization Requirement for Repayment”), XVI.M.1 (“Plan May Permit Suspension of Loan Repayments—But Interest Still Accrues”), XVI.M.2(“Capped Interest Rate”), and XXXIX (“Special Issues: USERRA and Other Military-Service Related Rules”).
Contributing Editors: EBIA Staff.