COVID-19 Loan Repayments—How Many Licks Does it Take to Get to the Center of a Tootsie Roll Pop?

What could getting to the chocolate center of a hard candy have to do with an expanded loan repayment period? Read on.

Some of you (older) readers might remember the Tootsie Roll Pop ad where a scholarly looking owl was asked how many licks it takes to get to the center of a Tootsie Roll Pop. One… two… three… crunch! The world may never know. 

What does this have to do with COVID-19 loan repayments? Not much, other than at the moment there remains some question as to how and when to resume loan repayments when there has been a suspension of loan repayments due to the CARES Act loan relief. And the key difference is how long do you think you should wait. 

By way of background, one of the relief provisions in the CARES Act is the delay of certain participant loan repayments. The Act provides that if a qualifying individual[^1]  has a loan repayment due during the period beginning on March 27, 2020, and ending on Dec. 31, 2020, then the repayment is delayed for one year. The law then provides that “any subsequent repayments with respect to any such loan shall be appropriately adjusted to reflect the delay in the due date… and any interest accruing during such delay.”[^2]

We’ve heard three different interpretations discussed. The first, and most common, is based on an application of a safe harbor approach outlined in the wake of Hurricane Katrina, from which the language of the extension is drawn. It assumes that repayments begin Jan. 1, 2021—and that the outstanding loan is re-amortized as of that date.  

The second interpretation also assumes that repayments begin Jan. 1, 2021, but that the loan isn’t re-amortized until the anniversary of the original postponement (April 2021). The third basically assumes that the repayments and re-amortization are all  postponed a year—so repayments don’t begin until April 2021, at which point the loan is re-amortized. The latter two alternatives are discussed below.[^3]

Let’s use a simple example to help explain the practical impact of the different interpretations. 

• Hedwig took a plan loan of $50,000 in July 2019
• The payments are $898 month
• The last repayment is due in July 2024 (5 years)
• Hedwig made payments through March 2020 (9 months)
• Hedwig is a qualified individual under the CARES Act (owls are people too)
• Loan repayments are suspended from April 2020—December 2020 (9 months)

What happens on Jan. 1, 2021? 

Under interpretation No. 1 (using Katrina safe harbor as a guidepost): Repayments begin on 1/1/21 based on a re-amortized loan. The law only suspends repayments due between March 27, 2020, and Dec. 31, 2020. This interpretation assumes that “subsequent” refers to repayments beginning after Dec. 31, 2020. Therefore, repayments must begin in January 2021. The amount of the repayments is determined by re-amortizing the loan as of Jan. 1, 2021, using the outstanding principal and accrued interest on that date. The term of the loan is also extended to April 2025 to reflect the 9 months that loan repayments were suspended. 

As noted earlier, this interpretation is consistent with a safe harbor method outlined by the IRS in Notice 2005-92, which interpreted the same provision with respect to Hurricane Katrina relief. It is not clear, however, whether this safe harbor approach would be applicable under the CARES Act. In 2005 the period during which loan repayments that could have been suspended under the Hurricane Katrina relief was longer than one year (Aug. 25, 2005—Dec. 31, 2006) and therefore participants were able to suspend repayments for at least one year (and in some cases longer). The problem with applying the safe harbor approach under the CARES Act is that it doesn’t provide a full one-year suspension of repayments that were due during the relief period, only through Dec. 31, 2020.[^4]

The IRS provided a safe harbor for Hurricane Katrina relief, but what’s the non-safe harbor method? The Notice, unfortunately, doesn’t provide any insight as to what the non-safe harbor might have been. This is why practitioners are struggling with this issue. 

Under alternative interpretation No. 2 (repayments begin in January 2021 and the repayment amount is adjusted started April 2021):  Loan repayments resume in January 2021 and the January, February and March repayments are equal to the original repayment amount. Similar to Interpretation #1, repayments resume in January 2021. But, here the loan is no re-amortized until the passage of a year, and thus the repayments for January 2021 through March 2021 are the original repayment amount ($898). In April 2021, when the end of the 1-year suspension for the suspended repayment that was due in April 2020 occurs, the loan is re-amortized based on the outstanding principal and accrued interest with a term that is extended one year (to June 2025). This interpretation would seem to be consistent with the law as written, at least if one interprets “subsequent repayments” to refer to repayments after the 1-year suspension period has expired (i.e., the only repayments that are adjusted are those due after the 1-year suspension period). One downside to this approach, however, is that the re-amortization calculation is much more difficult –  and so it’s unlikely many providers would prefer this interpretation.  

Under alternative interpretation No. 3 (all repayments are suspended for one year): No repayments resume until April 2021; all repayments are delayed a full year. At that point, the loan is re-amortized based on the principal and accrued interest and the remaining term of the loan, extended one year to June 2025. This interpretation is predicated on the notion that the adjustment for the payments in January 1, 2021 through March 2021 means they are adjusted by delaying the due date until the expiration of the 1-year suspension period. 

The appeal of this approach is that it’s simple—the loan is pushed back 12 months in its entirely, and so it provides participants with a long repayment suspension period. However, this “appears” to be suspending repayments in January through March, and the law only allows the suspension of loan repayments from March 27, 2020, through Dec. 31, 2020. Some practitioners have suggested that, at least in this example, even if it’s not a correct interpretation of the law, there’s no harm because loan repayments would begin in April, and that’s before the missed repayments from January 2021 from March 2021 would be defaulted (that argument would not work if the  loan originates late in 2020 (e.g., in November 2020) because there would be a default on the January 2021– March 2021 repayments by the time repayments begin in November 2021). 

In conclusion, while there appears to be some consensus emerging toward interpretation No. 1 (the Katrina model), at present there are alternative interpretations with different results. Unless, or until the IRS provides guidance, plan sponsors will need assistance in determining which interpretation to use. In some cases, this may be dictated by what service providers are able to accommodate. 

Participants need to understand the impact of the delay of repayments (a participant is not required to suspend repayments and could continue to make repayments on the loan). In addition, administrative and recordkeeping systems need to be updated, and this doesn’t happen overnight. In many cases providers have already made decisions on the approach they will take, and thus we can all hope that the future guidance will be tolerant of reasonable applications of the law.  

Robert M. Richter, J.D., LL.M, is the American Retirement Association’s Retirement Education Counsel. He is the editor of the ERISA Outline Book.

Footnotes

[1]. A qualifying individual is defined as someone: (1) who Is diagnosed with the virus (via test approved by CDC); (2) whose spouse or dependent is diagnosed with virus; or (3) who experiences adverse financial consequences as a result of: quarantine, furlough, laid off, hours reduced, unable to work due to childcare, closing of business, or other factors as determined by the Secretary of the Treasury.

[2]. Section 2022 of the CARES Act.

[3.] Here's a simple calculation showing the different impacts: A chart to show the approximate differences between the interpretations might be helpful.   

	Interpretation #1	Interpretation #2	Interpretation #3
January 2020  – March 2020	$898	$898	$898
April 2020 – December 2020	$0	$0	$0
January 2021  –	$919 – April 2025	$898 – April 2021	$0 – April 2021
April 2021 -		$920 – July 2025	$926 – July 2025

[4]. A variation on this approach is to begin repayments in January 2021, but when re-amortizing the loan, extend the term for one year, rather than 9 months. However, this seems contrary to the statute which states that the subsequent repayments be “appropriately adjusted” yet the participant only had the April 2020 repayment suspended for 9 months, not 12.