A Closer Look: Loan Increases and Repayment Relief

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The IRS issued frequently asked questions (FAQs) addressing plan loan changes on May 4, 2020, which stated that the Treasury Department and IRS anticipate releasing guidance on these provisions in the near future. In the interim, the FAQs advise employers to refer to IRS guidance issued in Notice 2005-92 which addressed similar loan provisions under the Katrina Emergency Tax Relief Act of 2005 (KETRA), for guidance on the loan provisions.

Plan Loan Increases

Section 2202(b) of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), enacted on March 27, 2020, increases the loan limits for any loan made from a 401(a), 403(b), or governmental 457(b) plan to a qualified individual during the 180-day period beginning on the date of enactment of the Act (March 27, 2020 through September 22, 2020). The CARES Act increases the maximum loan amount to $100,000 (currently $50,000) and permits loans up to 100% (currently 50%) of the present value of the participant's account. For this purpose, a "qualified individual" is defined using the same criteria applicable to coronavirus-related distributions (CRDs) (see the prior Closer Look on Coronavirus-Related Distributions).

As a starting point, a plan does not have to permit loans, and there is nothing in the CARES Act that requires a plan to permit loans. Accordingly, a plan that does not already offer loans would need to be amended to permit them if it wanted to take advantage of these increased loan limits. A plan that is adding the increased loan limit under the CARES Act must be amended to reflect that decision by the last day of the plan year beginning on or after January 1, 2022 (January 1, 2024 for governmental plans). However, if a plan is being amended to add loans generally, that amendment must be adopted by the end of the plan year in which loans are first permitted. In either case, it is important that an employer go through the plan's normal plan amendment processes in determining whether to permit loans (or loan increases) under the plan.

Even if a plan already permits loans, it does not have to permit loans in the maximum amount permitted by law, nor with respect to all money sources under the plan. Again, there is nothing in the CARES Act that requires a plan sponsor to expand its current loan limits or the money sources from which loans can be made. Accordingly, if a plan sponsor adopts the temporary loan increase under the CARES Act, the increase does not alter any of the loan restrictions that may otherwise be in effect under the plan's loan policy. For example, if a plan limits participants to one outstanding loan at a time, then a participant with an outstanding loan may not apply for a new loan with a higher maximum until the outstanding loan is fully repaid. Similarly, if a plan restricts loans to employee contribution sources only, the increased loan maximum will not change the sources from which the loan may be funded (although it may increase the amount that may be taken from permitted money sources). An employer would need to revise its loan policy if it wanted to make these types of changes.

Note also that if a participant has previously defaulted on a plan loan and has not repaid that defaulted loan to the plan, the participant is not eligible for another loan in any event, unless the plan sponsor permits loan repayment through payroll reduction. Additionally, ERISA plans may require spousal consent before a loan can be granted.

A participant must be a "qualified individual" to take advantage of the increased loan maximum. Unlike the statutory language establishing CRDs, the CARES Act does not contain a provision allowing the plan administrator to rely on an employee's certification that he or she is a qualified individual. In practice, however, vendors are administering this provision based on individual self-certification. This approach is consistent with IRS Notice 2005-92 which provided guidance on similar loan provisions under KETRA. In this guidance, the IRS provided that a plan administrator is permitted to rely on a participant's reasonable representations that such participant is a qualified individual, unless the administrator has actual knowledge to the contrary.
 
Delayed Loan Repayments

The CARES Act also extends the repayment dates for a qualified individual with an outstanding loan on or after the date of enactment of the Act under a retirement plan. If the due date for any loan repayment occurs during the period from March 27, 2020 through December 31, 2020, the due date for the repayment is delayed by one year. Any subsequent repayments of the loan are required to be adjusted to reflect the delayed due date and any interest accruing during such delay, and the period of the delay is disregarded for purposes of determining compliance with the five-year term limit and the amortization rules.

Only "qualified individuals" are eligible for this loan relief. The term “qualified individual” is defined using the same criteria applicable to CRDs and for the increase in loan maximums.

On its face, this provision appears to be mandatory. However, the IRS stated in its May 4, 2020 FAQs that this provision is optional, consistent with its interpretation of similar provisions under KETRA. A plan that is permitting loan suspensions under the CARES Act must be amended to reflect that decision by the last day of the plan year beginning on or after January 1, 2022 (January 1, 2024 for governmental plans). If adopted, suspension will not apply automatically. Since the suspension is only available to qualified individuals, participants with an existing loan cannot have their loan repayments suspended unless they first self-certify that they are a qualified individual.

Resumption of Loan Repayments

We do not yet have guidance on how a loan should be re-amortized and when repayments must resume once the one-year delay of payments due between March 27, 2020 and December 31, 2020 ends. However, IRS FAQs issued on May 4, 2020, refer to Notice 2005-92 for guidance on this question. Notice 2005-92 set forth a safe harbor for satisfying similar loan suspension provisions that was part of KETRA, under which a participant was required to resume loan payments upon the end of the suspension period, and the term of the loan was extended by the term of the suspension period. 

The payments were adjusted to reflect accrued interest and were required to be paid in substantially level installments over the remaining period of the loan, determined by adding the suspension period to the original loan period.

Automatic Loan Relief to All Taxpayers Under Notice 2020-23

Separately, and unrelated to the CARES Act provisions that provide loan relief to qualified individuals, the IRS extended deadlines of "time-sensitive actions" under Notice 2020-23 to all taxpayers. This includes any loan repayment to a plan that is due on or after April 1, 2020 and before July 15, 2020. The delayed due date is July 15, 2020. This applies regardless of whether the taxpayer is a qualified individual and regardless of whether the plan has adopted the loan relief otherwise available under the CARES Act.

If a participant delays his or her loan payment during this period (including by asking the employer to suspend payroll deduction of a loan being paid by payroll deduction), the plan may not treat a loan as in default due to the missed payment. Pursuant to Notice 2020-23, the period from the actual due date until July 15, 2020 must be disregarded in the calculation of interest, so interest should not accrue as a result of suspension of these payments. Note that the waiver of interest should also apply to any employee who suspends loan repayments under the CARES Act provision, for the period of the extension under Notice 2020-23 (i.e., through July 15, 2020), notwithstanding the CARES Act language that otherwise requires interest to accrue during the suspension period.

Given current projections regarding the pandemic, it is possible that the IRS may issue subsequent guidance to extend this deadline further.

For more information about the employee benefit implications of the COVID-19 pandemic and how they might affect your employee benefit plans, please contact any one of Ice Miller's Employee Benefits attorneys. Please contact our COVID-19 Task Force if you have any questions about managing the risks of the coronavirus pandemic. Also see our Coronavirus (COVID-19) Resource Center for additional resources, which is updated daily.

This publication is intended for general information purposes only and does not and is not intended to constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader's specific circumstances.