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A recent call with a financial advisor in Texas is representative of a common question on mergers and acquisitions.
Welcome to the Retirement Learning Center’s (RLC’s) Case of the Week. Our ERISA consultants regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans, and other types of retirement savings and income plans, including nonqualified plans, stock options, Social Security, and Medicare. This is where we highlight the most relevant topics affecting your business.
“One of my clients acquired the assets of another business. The seller terminated its 401(k) plan, and the employees became employees of the new company earlier this year. Some of the acquired employees had outstanding loan balances under the prior plan. Are the only options to 1) repay the loans in full or 2) pay taxes on the outstanding loan balances?”
The terminated plan's loan policy and plan document are the first places to check. The applicable terms may address immediate repayment, continued repayment following severance, cure periods, and the timing of a default or loan offset. These provisions can affect the timing and tax treatment of the outstanding loan.
When a retirement plan terminates, outstanding participant loans may be offset against a participant's account balance under the plan's terms. A plan loan offset generally is an eligible rollover distribution. If the offset qualifies as a Qualified Plan Loan Offset (QPLO), the participant has additional time beyond the normal 60-day period to complete the rollover under Treasury Regulation 1.402(c)-2(g).
A QPLO generally is a plan loan offset involving a loan that met the requirements of IRC Section 72(p)(2) immediately before the plan termination or severance from employment, and that occurs solely because of either:
The termination of the qualified employer plan; or
The participant's severance from employment and failure to meet the loan repayment terms because of the severance. For a severance-based QPLO, the offset must occur by the first anniversary of the severance.
Unlike a deemed distribution, which cannot be rolled over, a plan loan offset is treated as an actual distribution and generally is eligible for rollover. A plan loan offset that is not a QPLO generally is subject to the normal 60-day rollover period, while a QPLO receives the extended rollover period. IRS - Plan loan offsets
For a QPLO, the participant generally has until the due date (including extensions) for filing the federal income tax return for the year in which the offset occurs to complete the rollover. If the QPLO amount is rolled over within this period in a tax-free rollover, the offset amount generally is not currently taxable.
The participant generally can roll over a QPLO by using other funds to replace the offset amount. For example, if a participant has a $20,000 QPLO, the participant generally would contribute $20,000 from another source to an eligible retirement plan or IRA. A less commonly available but potential alternative, if the plans permit it, would be to complete a direct rollover of the participant loan note to another qualified plan that accepts the note. This loan-note option is not available for an IRA [Treasury Regulation 1.401(a)(31)-1, Q&A-16].
When a retirement plan is terminated as part of an acquisition or other business transaction, advisors should review outstanding participant loans before assuming the balances will automatically become taxable. The key questions to consider are:
What do the plan document and loan policy provide following severance from employment or plan termination?
Did the loan satisfy IRC Section 72(p)(2) immediately before the applicable event and, for a severance-based QPLO, did the offset occur within 12 months after severance?
Does the offset qualify as a QPLO, and what rollover deadline applies?
What rollover options are available - replacement funds after an offset or, if permitted, a direct rollover of the loan note to another qualified plan?
Early identification of these issues can help participants preserve the tax-deferred status of their retirement savings and avoid an unexpected taxable event.