QDRO NewWhen a participant takes a “loan” from their retirement plan, the plan liquidates investment assets in order to pay the participant cash from the plan. This means that when an account statement for a 401(k) plan states: asset balance $15,000, loan balance $5,000, there is actually still $15,000 worth of community property investments in the plan. It is worth noting that different banks report plan loans differently on statements, so the treatment of the loan should be double checked with the bank prior to arriving at a firm conclusion.
Arguably, a loan should not be thought of as a debt at all. Instead, it is way of cashing out pre-tax dollars from a retirement plan. The reason that a loan is not a debt is the subsequent loan payments made by the participant to repay the loan increase the participant’s plan balance. In other words, the participant is simply transferring funds from their checking account to their retirement plan. They are repaying themselves.
Despite the conclusion that a retirement plan loan is not truly a “debt,” there are special tax and transferability considerations to be taken into account. A participant loan is accompanied by a tax disadvantage for the participant who retains the plan because a participant repays the loan with after-tax dollars and then the participant is ultimately taxed on the benefits when they are withdrawn at retirement. Furthermore, a QDRO cannot assign a participant loan from the participant to an ex-spouse. Parties in mediation or preparing for trial may benefit from a brief analysis on how to equitably treat a retirement plan loan which can depend on the specific facts and circumstances.
The bottom line is that a retirement plan loan is unique and not generally treated as a community property debt obligation.