How and when a laid off or terminated employee must pay back a 401k loan before it reverts to a distribution (and is therefore taxable) will largely depend on the plan’s loan policy, which can be confirmed by the 401k plan administrator.
However, Jon Schultze with The Wagner Law Group has insight into what can/may happen to participants whose job is lost to the coronavirus economic fallout.
The firm recently established its COVID-19 Resource Center to answer employment and fiduciary matters related to the pandemic.
“Participants who are laid off/terminated generally have until the end of the calendar quarter following the calendar quarter in which repayments are missed to cure the missed repayments,” Schultze writes. “Otherwise, the participant will be taxed on the balance of the loan.”
Yet, he adds, employers may permit terminated employees to continue to make loan repayments, either from severance pay or from their personal accounts, but the plan’s loan policy must provide for the ability to make such repayments.
“Plan sponsors may amend their plan documents or loan policies to provide added flexibility within limits, including, in addition to the repayment options noted above, allowing participants to take more loans than are currently offered or additional money types that might otherwise be restricted.”
Plan sponsors also may modify their plan documents or loan policies to reflect changes made by the CARES Act.
“Legal limitations on loans from qualified plans have been relaxed,” Schultze notes.
As an example, he cites the limit on loans that increased from 50% of a participant’s vested account balance up to $50,000 to now 100% of the participant’s vested account balance up to $100,000. The loans are approved for “qualified individuals” made during the 180-day period from the date of enactment.
Important definition
A qualified individual is defined as someone who:
- Is diagnosed with COVID-19 by a CDC-approved test
- Whose spouse or dependent is diagnosed with COVID-19
- Who “experiences adverse financial consequences as a result of being quarantined, being furloughed or laid off, or having work hours reduced due to” COVID-19
- Is unable to work due to COVID-19 childcare issues
- Has closed or reduced hours in a business owned or operated by the individual, due to COVID-19, or
- Has experienced other factors as determined by the Secretary of the Treasury.
“The CARES Act also allows the plan to delay the due date for any repayment by a ‘qualified individual’ of a participant loan that would occur from the date of enactment through December 31, 2020, for up to one year,” Schultze concludes. “Later repayments for such loans are adjusted to reflect the delayed due date and any interest accruing during such delay. The delay period is ignored in determining the 5-year maximum period for such a loan.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
