(b)lines Ask the Experts – Re-borrowing After Repayment of a Defaulted Loan

“I work for a plan sponsor where payroll deduction and outside collateral cannot be used for loans. We have a participant who defaulted on a loan, but who later paid off the loan in its entirety. Do the Internal Revenue Service (IRS) regulations allow for re-borrowing in this situation?”

By PS

Stacey Bradford, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer: 

As is the case with many questions on loans, the Experts will turn to the regulations under 72(p) in order to provide a response to your question. Specifically, Treas. Reg. 1.72(p)(1), Q&A 19 states the following (boldface text is the Experts’ emphasis):

“(2) Additional security for subsequent loans. If a loan is deemed distributed to a participant or beneficiary under section 72(p) and has not been repaid (such as by a plan loan offset), then no payment made thereafter to the participant or beneficiary is treated as a loan for purposes of section 72(p)(2) unless the loan otherwise satisfies section 72(p)(2) and this section and either of the following conditions is satisfied:

(i) There is an arrangement among the plan, the participant or beneficiary, and the employer, enforceable under applicable law, under which repayments will be made by payroll withholding. For this purpose, an arrangement will not fail to be enforceable merely because a party has the right to revoke the arrangement prospectively.

(ii) The plan receives adequate security from the participant or beneficiary that is in addition to the participant’s or beneficiary’s accrued benefit under the plan.”

Thus, if the defaulted loan has been repaid, neither payroll deduction nor outside collateral is required for re-borrowing. However, there is nothing that would prevent a recordkeeper/investment provider from prohibiting re-borrowing after default, even a loan is repaid. And of course, a plan sponsor, via the plan document or Loan Policy Statement, can also prohibit re-borrowing after default even if a defaulted loan is repaid.

Finally, the Experts note that some grandfathered contracts are exempt from the loan default rules entirely.

 

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.  

Do YOU have a question for the Experts? If so, we would love to hear from you! Simply forward your question to Rebecca.Moore@strategic-i.com with Subject: Ask the Experts, and the Experts will do their best to answer your question in a future Ask the Experts column.

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