Loan Defaults and Military Leaves of Absence

“I have a question regarding the ‘cure’ period after which a retirement plan loan would go into default in relation to a military leave of absence.

“If a participant is on an authorized non-military leave of absence from her employer, Q&A-9 of Treasury Regulation Section 1.72(p)-1 provides that her participant loan repayments may be suspended for up to one year.


“What if the participant’s loan repayments were in arrears prior to the commencement of the leave of absence? Q&A-10 of Treasury Regulation Section 1.72(p)-1 permits a plan administrator to allow for a cure period ending no later than the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.


“Does the suspension permitted under Q&A-9 apply in this scenario, which would actually result in the cure period being extended by up to one year? Or is the suspension permitted under Q&A-9 applicable only where the loan was otherwise current when the leave commenced?”


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


Good question! Though there is not a direct answer to your question in the loan regulations that you cite, this is an example of how a careful reading of the regulations, and how they interact with each other, can help you arrive at your answer.


Let’s start with Q&A 10 of the regulations that you cite, which states the following:


“Q-10: If a participant fails to make the installment payments required under the terms of a loan that satisfied the requirements of Q&A-3 of this section when made, when does a deemed distribution occur and what is the amount of the deemed distribution?


“A-10: (a) Timing of deemed distribution. Failure to make any installment payment when due in accordance with the terms of the loan violates section 72(p)(2)(C) and, accordingly, results in a deemed distribution at the time of such failure. However, the plan administrator may allow a cure period and section 72(p)(2)(C) will not be considered to have been violated if the installment payment is made not later than the end of the cure period, which period cannot continue beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.”


So clearly, assuming that the terms of your plan allow for the maximum cure period as you state (cure periods are optional), the loan in question could not be defaulted until the last day of the calendar quarter following the calendar quarter in which the missed payment was due.


Now, let’s look at the relevant portion of Q&A 9 (text in boldface reflects the emphasis of the Experts):


“(b) Military service. In accordance with section 414(u)(4), if a plan suspends the obligation to repay a loan made to an employee from the plan for any part of a period during which the employee is performing service in the uniformed services (as defined in 38 U.S.C. chapter 43), whether or not qualified military service, such suspension shall not be taken into account for purposes of section 72(p) or this section. Thus, if a plan suspends loan repayments for any part of a period during which the employee is performing military service described in the preceding sentence, such suspension shall not cause the loan to be deemed distributed even if the suspension exceeds one year and even if the term of the loan is extended. However, the loan will not satisfy the repayment term requirement of section 72(p)(2)(B) and the level amortization requirement of section 72(p)(2)(C) unless loan repayments resume upon the completion of such period of military service and the loan is repaid thereafter by amortization in substantially level installments over a period that ends not later than the latest permissible term of the loan.” 


Provided that the plan document contains the military service rule, not only is there no obligation to repay a loan during the period of military service, but the period that loan repayments are suspended during military service “shall not be taken into account” for purposes of the loan rules (Code Section 72(p)).  In other words, the suspension period will not count against the participant for purposes of determining whether the participant failed to make a payment, or to correct a missed payment, on time. Thus, a loan that was NOT deemed distributed while an employee was in active employment with the employer (including on an approved non-military leave of absence) CANNOT be deemed distributed when the employee goes on military leave, since, as the Q&A clearly indicates, there is not an obligation to repay a loan at all during military service. 


Basically, the clock stops ticking on the loan repayment that was not paid prior to the start of the period of military service until the military service ends and normal, active employment resumes. At that point, loan repayments must resume; note that the regulations do not specifically state WHEN payment must resume, but since the obligation to repay the loan is no longer suspended, you would revert to the plan terms for loan repayment. Thus, if the plan terms provided for monthly repayment, the loan repayment for the current month would be due, as well as the payment that was missed prior to the military leave. Both payments would be subject to the applicable cure period as described in the plan document.


And, just to be clear, the suspension of loan repayments during military service is entirely optional.  The plan document must contain the rule for the “Military service” regulation to apply.


Thank you for your question!


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.


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