Top of Mind

CARES Act Loan Provision: The "Fly in the Ointment"

In a recent Top of Mind post, we discussed why plan sponsors should be wary of blindly adopting all of the CARES Act loan and distributions provisions. Well, it turns out that there is quirk in the CARES Act provisions regarding COVID-19 loans that is giving plan sponsors a reason to pause.

This issue is that while the CARES Act allows an increase in the loan limits for borrowers who qualify for a COVID-19 loan ($100,000 or 100% of a participant’s vested account balance, if less), it did not extend the repayment terms. Thus, the loan must be repaid over a five-year period, unless used to acquire a primary residence.

So, let us look a practical example of this problem. Consider an individual who has $100,000 vested in their retirement plan account. This individual’s plan sponsor allows for COVID-19-related loans, he/she has a qualifying CARES Act reason, and decides to borrow the full amount. Under the CARES Act, he/she is not required to make any repayments this year, so repayment begins in January of 2021 (assuming monthly repayments).

However, this individual now owes even more than $100,000, since the interest accrued in 2020 is not waived under the CARES Act. The total must now be paid off within the next five years; thus, repayments will be quite high. The concern lies when the individual, who likely needed the loan in the first place, cannot afford these payments. If the loan falls into default (the timing of this can vary by plan), then the entire amount becomes taxable as income in the tax year of default. Thus, the individual may go from owing his/her retirement plan, to owing the IRS - which is never a good thing!

Even worse, the individual could have treated that loan default as a COVID-19-related distribution under the CARES Act, had he/she defaulted in 2020. In that case, the individual would have qualified for all of the favorable tax treatment: a waiver of the 10% penalty if under age 59½, spreading out of the taxes over three years, or the ability to repay the distribution within three years to avoid taxes entirely, despite the loan already being in default. However, under the current CARES Act provisions, none of this tax relief is available for loan defaults that occur 2021 or later.

Let us contrast this to an individual who takes a $100,000 COVID-19 related distribution. Under the CARES Act, the individual can repay all, or some, of the distribution over three years; so, essentially, he/she is taking a three-year “loan” instead of a five-year loan. And, the individual can choose to repay some, or all, of the distribution at any point during that three-year period, with the portion repaid not taxable as income, while the portion not repaid is taxable (contrast this to a loan, where the ENTIRE outstanding loan balance is potentially taxable as income if a repayment is missed). Finally, even for the portion of the distribution that is not repaid, the tax burden is spread out evenly over three tax years (2020, 2021 and 2022) and the 10% penalty, for individuals under age 59½, does not apply (again, contrast to a loan, where the entire outstanding loan balance is taxable as income in the year of default, plus a 10% penalty if under age 59½).

With these examples, it’s easy to understand why some plan sponsors are allowing the CARES Act COVID-19 distribution provisions, but not the loan provisions. Of course, future guidance could be issued that would change all of this, but until then, plan sponsors should certainly be aware of this “fly in the ointment” that is the COVID-19 loan provision, before making a final decision.

Do you have any CARES Act retirement-related questions that are stumping you? Feel free to query me via LinkedIn, Twitter or at

Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.

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