How are outstanding loans treated for terminated employees?
When a participant with an outstanding loan is terminated there are three (3) options:
1) The former employee can pay back the entire balance within 90 days. The participant should write a check to the Plan and send it to the former employer who will include it in a transmittal to the recordkeeper/custodian.
2) The former employer may give the terminated participant the option of continuing the loan repayments. In this case, the former employee must submit checks (made out to the Plan) to the employer prior to each transmittal and the Employer will process in the usual manner.
3) Nothing is done. In this case, the loan will be considered “in default”. At the time of distribution (or earlier in some situations but never before 90 days), the outstanding balance will be treated as an early distribution. A 1099 will be issued to the former employee and applicable taxes and penalties will apply.