Hopefully while you were celebrating the holidays this year you noticed the U.S. Congress passed, and on Dec. 22, 2017 President Trump signed into law, the Tax Cuts and Jobs Act (TCJA). While there were proposals to make significant changes to the tax status of contributions and even the deferral limits, the approved bill makes few benefits changes.
However, I do want to discuss one specific change I think will be beneficial to retirement plan participants who have taken a plan loan.
One significant provision of the TCJA affects how the Internal Revenue Service (IRS) will treat plan loans for participants who are no longer employed by the company sponsoring the retirement plan from which their loan originated. Effective Jan. 1, 2018, the TCJA allows the participant an extension of time to satisfy outstanding loan obligations. This new rule may help participants who have borrowed money from their employer’s plan avoid unexpected taxation if they terminate employment or if the Plan terminates.
The TCJA “extends the period during which a qualified plan loan offset amount may be contributed to an eligible retirement plan as a rollover contribution.”[1]
“A plan loan offset is a foreclosure on a participant’s account that occurs when the participant defaults on a plan loan, such as following termination from employment when a plan states that the loan becomes immediately payable in full and the loan is not timely repaid. When an offset occurs, the unpaid loan balance is deducted from the participant’s plan account (the loan is “offset”) and the amount of the loan offset is reported to the participant on a Form 1099-R as an actual distribution.”[2]
Under the old rules, and subject to the specific rules of your retirement plan document, you generally had until the end of the quarter after the quarter in which you stopped making loan payments to pay off the loans. If you didn’t make this deadline, you were taxed on the amount of the loan principal not yet paid.
There are two ways a participant can avoid this taxation. First, the participant can repay the loan to the Plan before the distribution occurs, permitting the Plan to pay the participant the full account balance. The second option allows the participant to receive the balance, net of the offset from the Plan. They can then add from their taxable assets the amount of the offset to the IRA. This satisfaction of the loan obligation at the time of rollover preserves the tax status of the full distribution. Under the previous law, a participant had only 60 days from the date on which the loan was offset to complete either action, which is often too little time for a participant to come up with the money.
The new, current law provides participants more time. A participant who has a loan offset will have until his or her tax return due date (including extensions) for the year during which the loan offset occurred to roll over the taxable amount of the borrowed funds to an IRA or other employer plan. So, if a participant experienced the loan offset sometime during 2018, they would have until their tax return due date of April 15, 2019 (or, if they extended their return, until Oct. 15, 2019), to deposit the offset funds to an IRA or other employer plan.
This extension of time is available only if the loan becomes taxable due to a termination of employment or a termination of the Plan, and not because the participant had defaulted on the loan repayment while employed. This new wrinkle in the rules should be beneficial to many participants who receive unexpected offsets. However, you may need to amend your plan documents or loan policies to address this increased flexibility.
Notes:
[1] Tax Cuts and Jobs Act, Section 1505.
[2] Drinker Biddle, Plan Sponsor Update - The Impact of Tax Reform on Qualified Plans and Fringe Benefits, available at: https://www.drinkerbiddle.com/insights/publications/2018/01/plan-sponsor-update-the-impact-of-tax-reform-on-q
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