Good news out of Washington (really!)
With the release of Revenue Procedure 2019-19, the IRS has given plan sponsors a lot more tools in their toolbox to help correct issues with plan loans. The rules around loans have always been pretty inflexible. If a participant takes out a loan, Plan loan policies require that the participant makes regular, scheduled payments in accordance with their amortization schedule. If payments are missed, the loan can go in to default if the loan is not corrected quickly.
The Old Rules
In order to stay in compliance, loans cannot get behind schedule. But in the real world, this is all too common. Participants may not be paid regularly so loan deductions are not always deducted, the loan may get set up in the payroll system a little late, or the payroll system may glitch and not take out a loan payment when it should. We see issues like this happen all the time! If a loan did get behind schedule, the old rules gave us a very limited window to fix it - typically it needed to be fixed by the end of the quarter after the first payment was missed. This window for fixing a loan was called the "cure period". If the loan was not fixed by the end of the cure period, then the only option available to a plan sponsor to bring the plan back in to compliance was to default the loan. When the loan was defaulted, it was effectively re-characterized as a taxable distribution to the participant. Since defaulting the loan created a taxable event, the financial consequences could be very large. The consequences were even more significant to participants who were less than 59 1/2 years old because they would also be subject to a 10% penalty tax. If the original error occurred because of a payroll mistake, plan sponsors were often between a rock and a hard place with no ability to fix the issue without harming the participant.
Even when the loan issue was caught and corrected before the end of the cure period, the way the problem had to be fixed often posed significant hardship to plan participants. Since the loan had to be brought up to date before the end of the cure period, participants sometimes had to double or triple their loan payments to catch up quickly enough. In some cases, these additional payments on top of the regular loan payments really caused a financial burden for the plan participant.
The New Rules
The new rules provide much needed relief by giving plan sponsors additional ways to bring the loan back in to compliance. Significantly, loans that are behind schedule and outside of the cure period no longer need to be defaulted. Instead, the loan can be corrected by making up the missed payments by re-amortizing the loan over the remaining payments or by extending the loan passed the original duration so long as the loan does not exceed the maximum 5 year period. The first method of re-amortizing the loan will increase the payments for the participant, but since the missed payments can be spread over the life of the loan and do not need to be made up in a short period of time, the increased loan payment will pose less of a hardship. If the loan can be extended past the original due date, this option can be an even better solution for the participant since their payments will not increase.
The ability to correct the loan by making up the missed payments over the life of the loan or by extending the loan provides considerably more flexibility to plan sponsors and relief to plan participants. One thing to keep in mind is that the new rules do require that interest is accrued to reflect the longer loan duration and the missed payments. If the original issue was due to an error on the part of the plan sponsor, the employer must pay this additional interest amount rather than the plan participant.
We can help!
BlueStar will provide a monthly loan report and provide new amortization schedules if any of your loans fall behind. Together, we can make sure that your plan stays in compliance!