What Is a Loan Offset and How Do Recent Regulatory Changes Apply?
by Tyler Monda, CIP, CHSP
I have a client who terminated service from her employer and requested a distribution from the employer-sponsored 401(k) plan. The client had an outstanding loan from the plan, and when she requested the direct rollover, the plan administrator told her that the outstanding loan amount would be offset. What does that mean?
A loan offset occurs when a plan participant’s vested account balance is reduced by the outstanding balance of the loan at the time of an actual distribution from a qualified retirement plan. A loan offset can only occur when a participant has a triggering event (e.g., death, disability, severance from employment, etc.), which is dictated by the plan’s loan policy.
Example: Eric has a vested account balance of $100,000 and an outstanding loan amount of $10,000 on the date he terminates his employment. When Eric requests a full distribution to roll over directly to his IRA, the direct rollover is for $90,000 ($100,000 - $10,000).
What are the tax consequences of a loan offset to the participant?
Because a loan offset is an actual distribution from the plan, the participant will receive a Form 1099-R, Distributions From Pensions, Annuities, Retirement, or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., reflecting the distribution and will be responsible for including the loan offset amount in taxable income for the year in which the distribution occurred. However, if the amount of the loan offset is an eligible rollover distribution, the participant may delay taxation by rolling over the loan offset amount to another qualified retirement plan or an IRA. The participant can accomplish this by contributing the amount of the loan offset to the IRA or qualified retirement plan in cash. Participants are encouraged to consult their competent tax advisor to discuss their individual tax situation.
Example: In continuing with the previous scenario, Eric’s direct rollover to his IRA of $90,000 is equal to his vested account balance, less the amount of his loan offset. If Eric contributes $10,000 in cash to his IRA at the time of the rollover, the loan offset amount of $10,000 is not taxable to Eric in the year distributed.
What is the time frame for the participant to roll over the loan offset amount?
Prior to the Tax Cuts and Jobs Act of 2017, participants had 60 days following termination of employment to roll over the amount of the loan offset to an IRA or qualified retirement plan. Effective January 1, 2018, the 60-day period for rolling over the loan offset amount has been extended to the participant’s tax filing deadline, including extensions, for the tax year that the offset distribution occurred. But the extended period only applies to qualified plan loan offsets that are the result of either plan termination or the participant’s severance from employment. For a loan offset that occurs for any other reason (e.g., a plan may have a loan policy provision that offsets a loan upon the participant attaining age 59½), the 60-day time frame is still in effect.
How should the rollover of a qualified plan loan offset to an IRA be reported?
The financial organization should report the rollover contribution of a qualified plan loan offset on Form 5498, IRA Contribution Information, reporting the amount of a qualified plan loan offset rollover received beyond 60 days in Box 13a, Postponed/late contrib., and entering code “PO” in Box 13c, Code. If the loan offset rollover occurs within 60 days it should be reported normally in Box 2. Additionally, the participant should receive a Form 1099-R from his prior 401(k) plan recordkeeper to reflect the distribution, with code M in Box 7. Code M is a new reporting code introduced by the IRS in the 2018 Instructions for Forms 1099-R and 5498 for reporting distributions of qualified plan loan offsets.