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Rollover of Qualified Plan Loan – Tax Reform Extends Offset Payment Period

What do I need to know about the changes to the offset payment period?
Did You Know?

The recently released Tax Cuts and Jobs Act, enacted on December 22, 2017, and effective January 1, 2018, includes a provision intended to address plan loan defaults. The new provision addresses defaults that result in plan loan offsets and has extended the offset payment period for loans.

View example.

Who is impacted by the changes to the offset payment period?

The new rule primarily applies to participants who had a qualified plan loan that was outstanding, either at the time of termination of employment or termination of the plan.

What are Plan Loan Offsets and Rollovers?

Most 401(k) plans require the full repayment of an outstanding loan balance (plus interest) upon termination of employment. An offset occurs when the participant’s plan account balance is used to repay the loan.

The amount of the loan offset is reported to the participant on a Form 1099-R and is treated like a cash distribution, subject to a 10% premature distribution penalty (if the participant is under the age of 55).

The amount treated as distributed is eligible for a tax-free rollover to an individual retirement account or a new employer’s 401(k) plan which gives the participant an additional period of time to repay the loan and avoid a taxable distribution. Note: there is an automatic 20% federal tax withholding that the plan administrator must apply to an eligible rollover distribution that is not directly rolled over.

What do I need to know about the changes to the offset payment period? 

Prior to the Tax Cuts and Jobs Act, the IRS gave a participant 60 days to roll over the plan loan offset amount from a 401(k) or 403(b) plan account to an eligible retirement plan.

Under the new act, participants will be given more time (in many cases) to do a tax-free rollover or acquire the funds needed to pay off the loan. The time period is extended until the due date (with extensions) for filing the participant’s federal income tax return. As a result, the loan offset rollover period can be as long as 21 months when the loan offset occurs early in the calendar year and the participant requests an extension of his or her Form 1040 filing deadline for the year of the offset.

Action Items for Advisors, Plan Sponsors and Human Resource Managers

Advisors have a great opportunity to discuss the changes with plan sponsors and participants in plans which allow loans to address questions and provide up-to-date information on the tax impact of failing to timely repay loans.

  • Check plan documents and loan policy and procedure documents to determine if there are any deadline dates that need to be amended to reflect the changes made by the Act.
  • Update employee communications to reflect the additional time that may be allowed for a participant to repay the loan and still have the repayment treated as a tax-free rollover following a distribution of an offset loan from the plan. Participant must be aware that an accelerated loan repayment is due and failure to repay the loan results in a taxable distribution. They need to know that they have the ability to rollover a distribution to avoid taxes.
  • Establish procedures for accepting rolled over amounts into their plans that include loan offset amounts.
  • Plan sponsors may wish to coordinate administration of their plan loan offset rollover rules with the plan’s third-party administrator (TPA) in order to avoid inadvertently “defaulting” the participant’s plan loan.

Rollover Example:

You owe $25,000 on a 401k loan when you’re laid off on November 20, 2017. Your 401k balance is $75,000. You are unable to repay the loan within the 60-day period required by your plan and elect to do a rollover into an IRA.

On January 19, 2018, your plan offsets the outstanding $25,000 loan against the $75,000 balance and rolls over $50,000 into your IRA.

Under the old law, you have 60 days (until March 20, 2018) to roll over the offset amount ($25,000) into the IRA or a new employer’s plan. If you failed to do so, you would owe taxes on the $25,000 by April 15, 2019, the filing date for 2018 taxes.

Now, you may have until October 15, 2019 (the tax filing date for 2018 plus a six-month extension) to roll over the $25,000 to an IRA or new employer’s plan to avoid the tax hit. You can use that additional time to get back on your feet and avoid the taxes and penalties from a defaulted 401k loan.