
Quoting
Dealing with Loan Defaults by a Debtor in Bankruptcy
Generally speaking, a retirement plan does not have a “claim” (as that term is used in the bankruptcy context) against the employee’s bankruptcy estate for an outstanding loan balance. The consequence of this is that the employee’s obligation to the plan is not discharged (in either a Chapter 7 or Chapter 13 case) because the employee is not considered to have a dischargeable “debt” to the plan. That is, the employee’s obligation to the plan is not avoided by the bankruptcy process.
Consequently, if an employee in bankruptcy defaults on a plan loan, the bankruptcy rules do not appear to prevent the plan from applying its normal default rules. Thus, if the employee is still employed and an event entitling the employee to a distribution of elective deferrals has not occurred (a “distributable event”), the plan should declare a “deemed” distribution in accordance with IRS regulations governing plan loans. If a distributable event has occurred, the plan may offset the account balance by the amount of the outstanding loan.