Question

Which option below could happen in the event that a plan loan is defaulted upon for a participant who is 35 years old? (select all that apply)

Group of answer choices

The outstanding loan balance is fully taxable.

The loan can just rollover to an IRA.

A 10% penalty will be assessed on top of taxation.

Answer 1

Plan loans can trigger two kinds of taxable distribution: deemed distributions and plan loan offsets. A deemed distribution is a taxable event that occurs (a) when certain loan requirements are not met, e.g., if the loan’s repayment term is too long, the level amortization requirement is not met, or the loan is not evidenced by a sufficient legally enforceable agreement; or (b) upon a default if at that time the participant could not obtain a distribution (e.g., because the borrower is an active employee under age 59 ½). Although they result in taxable income, deemed distributions are not actual distributions and are not eligible rollover distributions.

By comparison, a plan loan offset is an actual distribution that occurs when a participant’s accrued benefit is reduced to repay a loan in accordance with the loan’s terms. That can occur if a participant defaults at a time when the participant could obtain a distribution (e.g., after attaining age 59 ½), or the participant requests a distribution and the loan, by its terms, must be treated as in default if it is not immediately repaid. (Plans sometimes allow participants to take a distribution of their unpaid loan, and roll over the loan note.

Here in it is deemed distribution BECAUSE ITS DEFAULTOR IS UNDER THE AGE OF 59 ½  hence A loan that is in default is generally treated as a taxable distribution from the plan of the entire outstanding balance of the loan (a “deemed distribution”). HENCE FIRST STATEMENT IS CORRECT

H deemed distribution is treated as an actual distribution for purposes of determining the tax on the distribution, including any early distribution tax. A deemed distribution is not treated as an actual distribution for purposes of determining whether a plan satisfies the restrictions on in-service distributions applicable to certain plans. In addition, a deemed distribution is not eligible to be rolled over into an eligible retirement plan. SO SECOND ONE IS NOT TRUE IN THIS CASE.

If you cannot pay the loan back (the loan defaults), then the unpaid amount is considered to be a taxable distribution and you could face a 10% penalty if you are under the age of 59½. SO THAT THE THIRD STATEMENTS IS TRUE.