A 401(k) plan may (but is not required to) permit a participant to suspend loan repayments during a leave of absence for military service. When loan repayments are suspended, the usual level amortization requirement is not violated even if the suspension exceeds one year and even if the term of the loan is extended beyond the statutory maximum period limit.
Loan repayments must resume upon completion of military service, and the frequency and amount of periodic installments may not be less than what was required under the terms of the original loan. The loan must be repaid in full (including interest that accrues during the period of military service) by the latest date permitted under the rules. This is typically five years, assuming the loan was not made for a principal residence, plus the period of military service.
Limit on interest rate charged. A maximum interest rate of 6 percent may be charged on a loan during a period of military service. A loan is subject to the interest rate limitation if:
(1) the loan was incurred prior to the military service; and
(2) the participant provides the plan with a written notice and a copy of the military orders within 180 days after the date of the participant's release or termination from military service.
Interest exceeding 6 percent must be forgiven. Note that "interest" includes service charges, renewal charges, fees, and any other charges (except bona fide insurance).
Adjustment may be necessary. If loan repayments are suspended during military leave, the plan must make an appropriate interest adjustment to the beginning of the military service. If, at the time notice is given, payments at a higher rate have already been made during the participant's period of service, the plan must make an appropriate adjustment (such as considering any excess payments as a prepayment of future interest).
Source: 26 CFR 1.72(p)-1; Employee Benefits Management Newsletter, 614, July 19, 2016.