HR and legal departments have likely confronted the unpleasant situation of having to inform a departing employee that in addition to no longer being employed by their company, they also have a rather limited period to repay an outstanding 401(k) plan loan. With what money am I supposed to do that?!? So goes the common refrain.
In a move that may be helpful in these situations, the 2017 Tax Act (the “Act”) provides additional relief for retirement plan participants in such a situation. Specifically, the Act extends the period in which participants with outstanding loans may repay owed amounts before the loan goes into default, triggering income inclusion and potential additional taxes for those under age 59 ½. Loan balances may now be repaid up to a participant’s due date (including extensions) for personal tax filings.
From a participant’s perspective, this change should be welcome relief as it:
- provides a longer period to repay outstanding retirement plan loans – the typical default deadline is the end of the calendar quarter following the quarter in which separation occurs; and
- contemplates that repayment may be made to a subsequent employer’s retirement plan or an IRA.
On the employer side; however, there are a few items that merit consideration. For instance:
- Consider reviewing and updating existing loan policies and employee communications in light of the extended repayment period.
- Determine whether your retirement plan will accept loan repayments for incoming employees with outstanding balances from a prior employer’s plan.
- Consider how, from a process perspective, to administer predecessor employer plan loans – what information is needed / how to obtain it.
All in all, extending loan repayment periods seems like a good idea. It helps participants in need avoid incurring additional income/penalties, while promoting keeping retirement benefits in the “retirement system”. Still, there may be significant administrative burdens associated with accepting loan balances from prior employer retirement plans that may make such process undesirable for employers. Perhaps, the ability to repay loan balances into an IRA may be the solution for those participants.