3962 / How can a plan participant who has taken a loan from his or her 401(k) plan cure a default on repayments?

IRS guidance explains situations in which a cure period may prevent missed installment payments on a 401(k) plan loan from causing the loan to be treated as a deemed distribution. Generally, a plan loan will be treated as a taxable deemed distribution unless it is paid in installment payments over the applicable five-year period.

A cure period that lasts up until the last day of the calendar quarter following the quarter when the missed installment payment was due may apply to prevent deemed distribution treatment. The IRS allows taxpayers to apply a later payment to an earlier missed payment to prevent deemed distribution treatment. The IRS uses the example of payments missed on March 31, 2020 and April 30, 2020, followed by on-time payments on May 31, 2020 and June 30, 2020 where a cure period ending June 30 applies. The May and June payments apply to “cure” the missed March and April payments, but then the normal May and June payments are treated as though they were missed because they were applied to cure the missed payments. As a result, the borrower is required to make an installment payment equal to three normal payments to bring the account up to date.¹

Further, a taxpayer who misses payments may also be permitted to refinance the plan loan in order to include the missed payments, but the refinancing must occur before the end of the applicable cure period.