Say what you will about 401(k) loans – and we have over the years – they are a fact of 401(k) life and were addressed in the recently passed Tax Cuts and Jobs Act (the “Act”). Before we get to the new rules, let’s start with the state of 401(k) plans. Recent data is difficult to come but a research report, An Empirical Analysis of 401(k) Loan Defaults, published by the Pension Research Council in 2010 can still provide us some insight.
For the three year period, July 2005-June 2008, one out of five active participants had loans; and, approximately 80% of 401(k) plan borrowers terminating employment defaulted on their loans – or approximately $600 million. So maybe a provision in the Act could be helpful to cut down the number and amount of defaults.
Prior to the Act, an employee who terminated employment with an outstanding loan generally had three repayment options:
- Pay the loan back which is rarely done, or
- Offset his or her account balance with the amount of the outstanding loan resulting in a taxable event, or
- “Rollover” that loan offset by contributing to the amount of the unpaid loan balance to an IRA with 60 days of leaving.
Effective for tax years beginning in 2018, the Act extends the rollover deadline from 60 days to the due date of the employee’s tax return including extensions.
It can make a big difference by providing additional time for an employee to avoid a taxable event. For example, an employee terminates employment on February 1, 2018 with an outstanding loan balance. Prior the Act, the employee had a 60-day deadline, or April 2, 2018, to affect the rollover. Now, the employee could deposit the offset funds as late at March 15, 2019 or until October 15, 2019 if an extension is filed.
Will this new provision put a dent in the number of loan defaults? Hopefully.
Image credit: Canstock Photo.