Options for Terminated Employees With Outstanding Loans

“I am switching between employers that both sponsor 403(b) plans. However, I have an outstanding loan and need to repay it in its entirety or the outstanding loan balance will be 2020 taxable income for me. Because of the COVID-19 pandemic, I do not have the means to pay off the loan. Is there any guidance that the Experts can offer?”

Stacey Bradford, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:

There sure is! First, you should determine whether you meet one of the following definitions of a “qualified individual” that is eligible for distribution relief under the Coronavirus Aid, Relief and Economic Security (CARES) Act, as follows:

1. You have been diagnosed with COVID-19;
2. Your Spouse or dependent has been diagnosed with COVID-19;
3. You experienced adverse financial consequences as a result of being quarantined, furloughed, laid-off, reduced work hours, inability to work due to lack of child care because of COVID-19, the closing or reducing hours of a business you own or operate due to COVID-19, or other factors, as determined by the Treasury Secretary (none have been announced as yet).

If you are indeed a “qualified individual”, the Experts have excellent news, you can treat that loan offset as a “Coronavirus-related distribution”, which means that you have a full three years from the distribution to either repay all or a portion of the loan to your former employer’s plan (if the plan allows for such repayment), or pay an amount to another retirement plan or IRA (up to the amount of the distribution). Any amount that you repay within this three-year period will NOT be subject to taxation! Even better, any taxes due on any amount that you do not repay can be spread out equally over three tax years. And finally, if you are younger than 59 1/2, this distribution would NOT be subject to the 10% penalty that would normally apply to such distributions. This relief applies to up to $100,000 in total retirement plan/IRA distributions you may have, including loan offsets, in 2020.

Even if you are NOT a qualified individual as described above, all hope is not lost. A few years ago, the IRS relaxed the rules for how they treat retirement plan loan offsets in general. Thus, even if you are not affected by COVID-19, because the loan offset is due to your severance from employment, you still have time to come up with the cash to pay off your loan. You have until your 2020 tax filing deadline (generally April 15th, 2021 unless extended) to pay off the loan via a rollover of the funds to a retirement plan or IRA. Thus, you still would have several months to pay off the loan. If you are still unable to pay off your loan by your tax filing deadline, you would be subject to income taxation on the amount of the loan offset for 2020, plus a 10% penalty if you are younger than 59 1/2.

Finally, if you are not affected by COVID-19 now, but become a “qualified individual” later this year, you can still take advantage of the COVID-19 distribution relief described above.

Good luck!

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.