We recently took over administrative services for a 401(k) plan. One participant has a loan that is in default and we have told the company that we will provide Form 1099 for the deemed distribution of this loan. The company agrees.

In reading the rules about defaulted loans, it seems that although the loan is in default and is considered a deemed distribution, the participant is still supposed to pay it back. And, according to the ERISA Outline Book, the plan sponsor should continue to try to get the loan repaid.

The participant with the defaulted loan could begin making payroll-deducted loan payments. However, if she is going to pay the tax on the deemed distribution anyway, why would she pay the loan back? If she did, would the loan repayments then be after-tax dollars in the plan? What if the plan does not allow for after-tax money?

Q&A 21 of the 2000 72(p) regs which provides that a participant has "basis" in any payments made on a deemed loan. It is more likely that the plan does not allow "aftertax contributions" (as opposed to "aftertax money").

Katherine:

Thank you for your help. I printed out the information you referenced. That seems to be all I need.

Kate Smith