Issue Snapshot - Plan Loan Cure Period

 

In August 2017, the Office of Chief Counsel issued Chief Counsel Advice (CCA) 201736022 that deals with the cure period described in Treas. Reg. § 1.72(p)-1, Q&A‑10(a) for participant loan repayments. This snapshot discusses common scenarios involving the cure period.

IRC Section and Treas. Regulation

  • IRC Section 72(p)
  • Reg. Section 1.72(p)-1

Resources

  • Chief Counsel Advice 201736022, August 30, 2017
  • EP Exam Phase II Training, Chapter 16, Participant Loans

Background

A loan from a retirement plan to a participant or beneficiary is treated as a taxable distribution from the plan unless it meets the requirements of IRC Section 72(p)(2) and Reg. Section 1.72(p)-1. Generally, these include:

  1. Legally enforceable agreement – the loan must be documented in a legally enforceable written agreement specifying the amount and date of the loan and repayment schedule. Reg. Section 1.72(p)-1, Q&A-3(b).
     
  2. Amount – the loan, when added to the outstanding balance of all other loans from all plans of the employer, must not exceed the lesser of --

(i) $50,000, reduced by any excess, if any, of --

(I) the highest outstanding balance of loans from the plan during the 1-year period ending on the day before the date on which such loan was made, over

(II) the outstanding balance of loans from the plan on the date on which such loan was made; or

(ii) the greater of

(I) one-half of the participant’s vested interest, or

(II) $10,000. 

IRC Section 72(p)(2)(A), (D).

  1. Term – the loan agreement must require repayment within 5 years (with an exception for the principal residence of the participant). IRC Section 72(p)(2)(B).
     
  2. Level payments – the loan must have a substantially level amortization schedule, with payments no less frequently than quarterly. IRC Section 72(p)(2)(C).

A loan that does not satisfy one or more of these requirements, either initially or at some later date, is treated as a deemed distribution from the plan as of the first date the requirement is not met. Reg. Section 1.72(p)-1, Q&A-4 and Q&A-10.

Level Amortization Requirement

A participant loan agreement must require substantially equal installment payments over the loan term, with payments due no less frequent than quarterly (the “level amortization requirement”). IRC Section 72(p)(2)(C). Loan repayment cannot be made at irregular intervals over the loan term.
If payments are not made timely, the loan no longer satisfies this level amortization requirement. The first late installment generally causes the remaining outstanding loan balance, including accrued interest, to be deemed distributed as of the missed payment date. Reg. Section 1.72(p)-1, Q&A-10(a), (b).

Cure period

A plan administrator may, but is not required to, allow a cure period during which a delinquent participant loan may be brought back into compliance without triggering a deemed distribution. If allowed, the cure period must be specifically provided for in the written plan document.

If this option is adopted, the maximum allowable cure period would extend to the last day of the calendar quarter following the calendar quarter in which the required installment payment was due. Reg. Section 1.72(p)-1, Q&A-10(a). The plan administrator may also adopt a shorter cure period, or none.

The following table illustrates the latest permissible cure date for a missed loan payment, assuming the plan administrator uses the longest cure period allowed by the regulations.

Month of Missed Payment Latest Permissible Ending Day of Cure Period
January – March (Q1) June 30 (last day of Q2)
April – June (Q2) September 30 (last day of Q3)
July – September (Q3) December 31 (last day of Q4)
October – December (Q4) March 31 (last day of Q1)

If a loan repayment is still late even after considering this cure period, then the amount of the deemed distribution is equal to the entire outstanding balance of the loan (including any accrued interest) as of the last day of the cure period. Reg. Section 1.72(p)-1, Q&A-10(b).

Examples

CCA 201736022 describes two ways in which missed installment payments can be made up during the cure period. One involves making up the missed payments during the cure period. The other involves refinancing the existing loan, also within the cure period.

These methods are illustrated in the examples below, along with other common scenarios involving cure periods.  

The examples assume the following common facts:  

  • Participant A is a participant in an IRC Section 401(k) plan that permits plan loans.
  • On January 1, Year 1, Participant A receives a loan from the plan in an amount that does not exceed the limit provided under IRC Section 72(p)(2)(A).
  • The loan term is five years with the last installment payment due December 31, Year 5, as required under IRC Section 72(p)(2)(B).
  • Level installment payments are due at the end of each month over the repayment term of the loan, as required under IRC Section 72(p)(2)(C).
  • The loan is evidenced by a legally enforceable written agreement, as required under Reg. Section 1.72(p)-1, Q&A-3(b).
  • The plan allows the maximum permissible cure period permitted under Reg. Section 1.72(p)-1, Q&A-10(a), which is until the last day of the calendar quarter following the calendar quarter in which the payment was missed.

Example (1) Timely payments shifted to cover late payments

Participant A is in Year 2 of the loan repayment schedule when she misses two payments (March and April). She then makes two timely payments (May and June) before catching up with a triple payment in July.
 

Scheduled Payment  Date Action Last Day to Cure Date Cured Timely?
March 31 Missed June 30 May 31 (shifted) Yes
April 30 Missed September 30 June 30 (shifted) Yes
May 31 Payment made but applied to March so considered missed September 30 July 31 (shifted) Yes
June 30 Payment made but applied to April so considered missed September 30 July 31 (shifted) Yes
July 31 Triple payment; applied to May, June & July n/a n/a Yes

The two missed installment payments (March 31 and April 30 of Year 2) have separate cure periods because they occur in separate calendar quarters. Each missed installment is cured by the timely installment payments made on May 31 and June 30 of Year 2, which are shifted to cover the missed installments. However, shifting the May 31 and June 30 installment payments to cover March 31 and April 30 missed installments causes the May 31 and June 30 installments to be considered missed.  The May 31 and June 30 missed installments are then timely cured by the triple installment payment made on July 31.
 
The participant’s missed installment payments do not violate the level amortization requirement under IRC Section 72(p)(2)(C) because the missed installment payments are corrected within the applicable cure period. Accordingly, there is no deemed distribution of the loan due to the missed installment payments.

Example (2) Shifted payments too late to cure

In a variation on the facts in Example (1), Participant A is in Year 2 of the loan repayment schedule when she misses four payments (March, April, May and June). On July 3, she makes a double payment equal to the missed March and April installments.
 

Payment Date Last Day to Cure Date Cured Timely?
March 31 (MISSED) June 30 n/a No
April 30 (MISSED) September 30 n/a n/a
May 31 (MISSED) September 30 n/a n/a
June 30 (MISSED) September 30 n/a n/a
July 3 (double payment) n/a n/a n/a

In this example, the make-up installment payment was received after the end of the cure period for the March 31 installment. As a result, Participant A has a deemed distribution on June 30. The amount of the deemed distribution is the outstanding loan balance (including accrued interest) on June 30. However, because the participant made loan repayments after the deemed distribution occurred on June 30, the participant has an investment in the contract (tax basis) equal to the amount of the payment made on July 3. See Reg. Section 1.72(p)-1, Q&A-21.

Example (3) Refinance of outstanding balance

Participant A is in Year 2 of the loan repayment schedule when she misses three payments (October, November and December). On January 15 of Year 3, she refinances the original loan and replaces it with a new loan equal to the outstanding balance of the original loan, including the three missed payments, with level monthly payment installments through the end of the original loan term, December 31, Year 5.
 

Payment Date Last Day to Cure Date Cured Timely?
October 31 (MISSED) March 31 January 15 (refinance) Yes
November 30 (MISSED) March 31 January 15 (refinance) Yes
December 31 (MISSED) March 31 January 15 (refinance) Yes
January 15 (refinanced loan) n/a n/a  

The missed payments are in the fourth calendar quarter and have the same cure period ending March 31, Year 3. Each missed installment is cured by the timely refinancing of the loan prior to the end of the cure period.

The participant’s missed installment payments do not violate the level amortization requirement under IRC Section 72(p)(2)(C) because the missed installment payments are corrected within the applicable cure period. Accordingly, there is no deemed distribution of the loan due to the missed installment payments.

Audit Tips

  1. Review the plan document to determine if the plan allows participant loans.
  2. Does the plan document allow for a cure period? If so, what is the duration of the cure period?
  3. Review the loan agreement to verify that the repayment terms meet the level amortization requirement of IRC Section 72(p)(2)(C).
  4. Is there an adequate accounting for participant loans?