As a general rule, qualified retirement plans that permit participant loans must charge a commercially reasonable rate of interest on all loans from the plan to participants or beneficiaries (DOL Reg. Sec. 2550.408b-1(e)). However, this general rule is preempted when the Servicemembers Civil Relief Act applies to a plan loan (the “SCRA”).

What Does SCRA Do?
If a Servicemember obtains a plan loan before entering military service, then the interest on such plan loan may be capped at 6 percent per year. SCRA defines “interest” broadly to include all service charges, renewal charges, fees, or other charges (except for bona fide insurance) with respect to a plan loan. Essentially, the normal plan interest rate is charged if it is less than 6 percent, but a 6 percent interest rate is charged, if the normal rate exceeds 6 percent. Note that a court may grant a plan administrator an exception if the servicemember is able to pay interest at the higher right without material affect from military service.

Who is Protected by SCRA?
The SCRA protects “servicemembers.” A servicemember includes a member of the Army, Navy, Air Force, Marine Corps, and Coast Guard. It also includes a member of the commissioned corps of the National Oceanic and Atmospheric Administration or the Public Health Service.

Why Does the SCRA Cap Interest?
The Servicemembers Civil Relief Act protects military servicemembers from the adverse impact of military service on their ability to fulfill financial obligations and assert legal rights. Note, the 6 percent interest rate cap is not applicable to new loans taken while on active duty.

When does SCRA Apply?
SCRA applies when (1) the servicemember (or the servicemember and his or her spouse, jointly) have obtained a plan loan and (2) the servicemember enters military service. Military service includes:

  • Active duty by a member of the Army, Navy, Air Force, Marine Corps, and Coast Guard;
  • Active service of a member of the National Guard if called by the President or Secretary of Defense for at least 30 consecutive days to respond to a Presidentially-declared and Federally-funded national emergency; or
  • Active service by a commissioned officer of the National Oceanic and Atmospheric Administration or the Public Health Service.

Military service also includes any period such servicemember is absent from duty due to sickness, wounds, leave, or other lawful cause.

How is SCRA’s Interest Cap Invoked?
A plan is only subject to SCRA’s interest limit if the servicemember provides written notice and a copy of the military orders calling him or her to military service (or further extending military service). This notice and copy must be provided no later than 180 days after the date of the servicemember’s termination or release from military service. If such notice is given, the plan must impose a plan interest rate of no more than 6 percent effective as of the date the servicemember is called to military service. Note that notice may be given retroactively, which may require the plan trustee or plan administrator to recalculate interest that has already accrued. This can present administrative difficulties.

If a participant returns to re-employment, under Uniformed Services Employment and Reemployment Rights Act (“USERRA”), then the participant must resume loan repayments when the military service ends. Repayments must have the payment frequency and amount at least equal to the pre-military schedule. The rehired veteran must repay the full loan amount (including interest accrued during the military service period) by the end of the maximum term for the original loan (generally 5-years) plus the military service period (the requirement for loan re-payments may be suspended during the period of service). If SCRA notice is not given on re-employment, loan repayments may be calculated on a rate in excess of 6 percent, but if notice is given later, loan repayments must be recalculated and credit given for excess payments made during the period from re-employment to re-calculation.

The participant may not return to re-employment under USERRA. A former servicemember has only up to 90 days after discharge (if service has been more than 180 days) to claim re-employment (shorter periods apply for shorter periods of service). If the servicemember does not return to re-employment, the plan may treat participant loan as being in default according to its normal rules. The taxable portion of the deemed distribution may be determined upon the normal interest rate; however, if SCRA notice is given within 180 days of discharge, the interest portion of the deemed distribution will need to be re-calculated and a new information return (Form 1099-R) may be required.

Given this possibility, plan fiduciaries may be inclined to limit interest to 6 percent whenever a participant enters military service without regard to a requirement for a SCRA notice. However, it is not clear whether this approach satisfies ERISA’s requirement that the plan charge a commercially reasonable rate of interest because SCRA’s pre-emption of ERISA may not be triggered without the participant satisfying the procedural notice requirements of SCRA. Since a retirement plan participant loan program is an exception to ERISA’s prohibited transaction rules, caution is advised.

How Do I Get More Information?
Fraser Stryker is a leader in employee benefits and tax law. Attorneys in the Firm’s Employee Benefits and Taxation Practice Groups advise businesses, governments, and nonprofit/tax-exempt organizations on a wide variety of tax and employee benefits matters, transactions, and litigation. Fraser Stryker helps employers implement and maintain innovative and cost-effective employee benefit plans that attract and retain top talent. For more information, please contact Nicole R. Konen.

