Special Rule Regarding Loans for Participants on Military Leave

“I recently read your Ask the Experts column indicating that plan sponsors could permit suspension of loan repayments during a military leave of absence. Are there any other rules involving loans for those on military leave that I should know about?”

Charles Filips, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

There is one additional rule, and, though its applicability has been limited in recent years, it is possible that the rule may come into play in the not-so-distant future.

The additional rule concerns the interest rate that may be charged on plan loans to military service members. The Servicemembers Civil Relief Act, or SCRA (P.L. 108-189), limits that rate to 6% annualized during a period of military service. The vast majority of plans have not charged anywhere near a 6% interest rate on loans in recent years due to the historic lows in interest rates; however, given the Fed’s recent interest rate hike, with more hikes planned, we may find that this 6% cap will be relevant in the future.

Note that the cap can be tricky to administer, as the 6% limit only applies during the period of military service, and the loan could have been issued prior to the period of military service at a higher interest rate. The SCRA forgives the payment of interest in excess of 6% a year on any loans incurred by a service member, or jointly by the service member and his or her spouse, prior to the service member’s entry of military service. Thus, coordination of this provision with the plan’s recordkeeper and/or third-party administrator will be critical to ensure compliance.

Interest rate relief under the SCRA applies only if the service member provides the plan administrator or employer (as applicable) with written notice and a copy of his or her military orders or “other appropriate indicator of military service,” such as a letter from a commanding officer. Many plan sponsors simply impose the 6% interest limit on any outstanding plan loan of a servicemember on military leave regardless of formal notification. This is because the U.S. Attorney General is authorized to file a federal lawsuit against any person (or entity) who engages in a pattern or practice of violating the SCRA, so the consequences of violating that 6% interest limit can be severe.

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.

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