Must 401(k) loans be repaid upon separation from employment

by Curtis Farmer on September 19, 2011

in Administrative,Compensation,Questions

Finance

Issue: Many of your employees have taken out loans from their 401(k) plan accounts in the last few years. You have a rather large downsizing of employment coming up. Can your plan allow the participants to continue making payments on the loans or do the loans have to become due within a certain timeframe, such as 60 days?

Answer: It depends. Your separated employees can continue to repay their loans in substantially equal installments, if the plan allows it. Check your plan documents, and check with your plan administrator. You also would have to determine how problematic it would be, from an administrative angle, to succeed with that repayment strategy since payroll deduction (the method used with employees) would no longer be possible.
Also, while the law does not prohibit continuing repayment after termination of employment, it is clear that once the “contract” has been violated (i.e., the repayment schedule is no longer met by a former employee), there is a deemed distribution. Making sure the payments are made on time and in equal installments is a challenge that many administrators do not want to tackle.
Because a loan in default is considered to be a plan asset, interest on it continues to accrue even if the loan is treated as a deemed distribution. However, that accrued interest is not included in a 401(k) participant’s income.

 

Source: Curtis Farmer & CCH

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