(b)lines Ask the Experts – When Is a Loan Considered to Be in Default?

“I noticed that you have written a number of Ask the Experts columns regarding loan defaults, but none of those Q&As appear to answer a basic question that I have. When is a loan considered to be IN default?”

Michael A. Webb, vice president, Cammack Retirement Group, answers:     

That is an excellent question, and the Experts agree that this issue has not been addressed in any prior Q&As. As the Experts often do, we will turn to the relevant regulation—in this case, Treas. Reg. §1.72(p)-1, Q&A-10(a)—to respond to your question, That regulation states the following:

“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, though technically a failure to make any payment by the due date results in a defaulted loan (and related deemed distribution), the plan is allowed to allow for a grace/cure period to provide time for the participant to address a late payment. The length of the grace period is established by the plan administrator, typically in consultation with the plan’s recordkeeper. This grace period can extend no longer than the last day of the calendar quarter following the calendar quarter in which the missed payment was due. For example, if the plan was using the maximum grace period, and the participant missed a loan payment due July 1st, the participant would have until December 31st to make the payment in order to avoid a default.

The plan administrator could elect to use a shorter grace period, but should consult with its recordkeeper(s) prior to doing so to determine if a shorter grace period can be accommodated.

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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