Rollover Period for Retirement Plan Loan Offsets

Changes in 2017 give participants more time to come up with the funds to accomplish a tax-free rollover

If a participant defaults on a retirement plan loan after they separate from service, the plan will “offset” the outstanding balance of the loan, deducting it from the participant’s account and treating it as a distribution. The Internal Revenue Service (“IRS”) considers a loan offset an actual distribution, reported on a Form 1099-R. The amount is taxable to the participant and subject to the 10% additional income tax on early distributions, unless an exception applies.

Simply put, since the outstanding loan balance was not repaid, that portion becomes an actual distribution to the participant and therefore subject to taxation. Prior to the Tax Cuts and Jobs Act of 2017, if a participant wanted to defer taxes on that unpaid loan balance, they had 60 days to roll the cash value to another eligible retirement plan or IRA. With the update in December 2017, that deadline was extended to the due date for the participant’s tax return, including extensions, for the year in which the loan offset occurred.

Example -

A participant separates from employment and requests a rollover of their account balance. At that time, they have a $50,000 vested account balance which includes the value of a $5,000 outstanding loan that will not be repaid. The loan offsets against the account balance and the participant rolls over $45,000 to an IRA, deferring taxes on that amount. The $5,000 loan offset will be a taxable distribution.

Under the old rule, the participant could perform an indirect rollover by coming up with the $5000 in cash and rolling it to the IRA within 60 days of the loan offset. With the change to the law in 2017, the participant has until their tax filing deadline to come up with that cash to complete the rollover.

While this change did not impact the operation of the plan, from a participant’s perspective it could mean more time to come up with the funds necessary to complete a rollover in order to defer taxes. The rule applies only to plan loan offset amounts resulting from a participant’s termination of employment or the employer’s termination of the plan.

If you have any questions about this topic, please contact your Fidelity representative.

The rule applies to tax-qualified retirement plans, including 401(k), 401(a), 403(b) and governmental 457(b) plans that offer loans.
For plan sponsor and investment professional use only.
Fidelity Investments Institutional Operations Company, Inc.
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