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part. wants to default on loan


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I haven't discovered anything that would prevent a participant from voluntarily defaulting on a loan and paying the taxes. Am I missing anything other than it would affect the amount he could have on any future loans?

thanks

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Guest Sieve

There is nothing to prevent that, especially since state law usually permits any voluntary (or involuntary) withholding from an employee's pay to be revoked by the employee. Even if the plan or its loan program, by its terms, requires payroll withholding in order to take out or continue a loan, the penalty for violating that provision is merely default of the loan. I would argue, however, that if the fiduciary has actual knowledge that the employee intends to do that--i.e., borrow the funds and then cease to permit payroll withholding--then permitting the loan might well be a fiduciary breach.

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Are loan repayments required be made by payroll deduction? If so, the employer may be engaging in a pt or other fiduciary breach if it stops payroll deduction.

If payroll deduction is not required, that puts the responsible plan fiduciary in the position of having to worry about whether it has a fiduciary obligation to go chase the participant for the loan repayments, which is why it is almost always (if not always) a bad idea to permit loans without requiring mandatory payroll deduction.

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Guest Sieve

One would expect so, but I have not seen a case so provide--nor has the DOL opined on it, that I know of. This would be a law of general application, which applies to payroll in general and is not directed at pensions, so it might be held not to be preempted--although it does have an impact on plan administration. I would be hard-pressed, though, to advise a client to violate state payroll laws. Even though the plan might require loan repayment to be by payroll withholding, the loan then simply ceases to be a loan if payroll withholding stops, and that would not violate the terms of the plan once the default occurs since there no longer would be a loan as a result of the automatic default--so I don't see a PT or operational plan violation, in any event. It would be an operational violation, in that instance, however, if the loan was continued and payments were made by check.

OK - I just saw masteff's link to prior discussion (before my commencement of active posting). So, we can save everyone the necessity of rehashing the arguments. But, hey, these things can be fun (sometimes) . . .

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Guest Sieve

Let me say, however, that I disagree with a statement made on the earlier string that "in a plan that allows only one loan, the person will not be able to take another loan since the defaulted loan will remain an obligation of the participant until an offset can occur." The loan regs say that a defaulted, deemed distributed loan is considered outstanding only for purposes of determining the maximum amount of outstanding loans for purposes of determining the amount of a subsequent loan. I think, therefore, that the plan would have to specifiy that a defaulted loan continues to be a loan for purposes of determining the number of outstanding loans in order to count this as the only loan in a one-loan maximum plan.

I found the following to be interesting, by the way (although it is not the DOL speaking): look at Treas. Reg. Section 1.72(p)-1, Q&A-19(b)(2)(i), which says that a loan after a deemed distribution must require repayment by payroll withholding which must be enfoceable under applicable law, but that an agreement to such effect "will not fail to be enforceable merely because a party has the right to revoke the arrangement prospectively." The IRS is not interested in preemption, but certainly is aware of state payroll laws which usually will allow the revocation of the payroll withholding agreement.

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On the other hand, the IRS might be contemplating instances where ERISA did not apply (e.g., gov'tal plans, church plans, 1-person plans).

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I think it is a breach of fiduciary duty to let a participant default when the fiduciary can reasonably prevent the default, such allowing the participant to cancel payroll deduction when the participant does not have an overriding right to do so. Then the fiduciary has to decide if the fiduciary must try to collect on the debt by other means even if the participant managed to arrange a default.

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Since the plan is not the employer, and the payroll (and deduction/reduction agreements) is between employee and employer, How can the plan and/or its fiduciary exercise any control over stopping payroll deductions ?

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Contract between which parties?

Which contract ?

The salary reduction is between employer and employee. As far as I know, barring a court order, usually only parties to a contract have standing.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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As to Sieve's last comment about giving the IRS credit, we're talking about the people who write and review the regs., and they are at the highest levels of experience in Chief Counsel and the Commissioner's office and within the Treasury. We may not always like what they do, but don't ever sell them short in the knowledge department.

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Just for the record, in case someone stumbles on this thread and doesn't link to the other, I strongly disagree that a sponsor has any fiduciary duty to prevent a loan default by forcing a participant to continue payroll loan deductions. I see no harm to the plan if the loan defaults, and also think it's a wild stretch to connect payroll functions to plan functions.

I'm not sure I ever said it before, but I agree with GBurns!

Ed Snyder

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Why are loans serviced through payroll deductions? Because the plan administrator, through some contract, will not lend the plan money unless the the payroll deduction arrangement is put in place. That creates a relationship among the employee, the employer and the plan. Since the plan is allowed to make loans only with the expectation that they are to be repaid, and since the payroll deduction is the repayment mechanism that has been chosen, the plan administrator should make sure that the arrangement (contract) serves it purpose properly to support the administrtor's duty to arrange for loans to be paid. Commercial lenders do not make loans with optional payment.

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Commercial lenders do not make loans with optional payment.

Just to take your example out a few steps.... Very few commercial lenders mandate automated payments. They provide it as a servicing option but the automated payments can be cancelled by the borrower, who continues to be responsible for making payment via manual payment to the lender. It is only after the manual payments go into arrears that lender excercises the default clause in the loan agreement.

The case is not that the plan has made payment "optional" but has allowed the borrower to revert from automated payments to manual payments, which if not maintained will then result in default.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Following up on QDRO's comment, I think the employer is acting as a fiduciary in connection with a plan transaction when it agrees to implement payroll deduction, so it would be acting as a fiduciary in agreeing to stop payroll deduction (assuming it doesn't have to stop as a matter of state law). The result is a breach of fiduciary responsibility under ERISA. This is not something which the employer would want to be found in a DOL audit of the plan, because the DOL is likely to find that there has been a "loss to the plan" caused by that breach, notwithstanding the participant's request to cause the loss.

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Guest Sieve

jpod - My comment re: not giving the IRS credit simply was meant to indicate that I doubt the IRS would provide one rule for ERISA-covered plans and another rule for non-ERISA covered plans. And, when it comes to pre-emption, it's not an IRS call, so I don't think the IRS would presume that employee cancellations of payroll withholding are or are not pre-empted. I am not selling them short in the knowledge department, but just indicating that they typically do not consider DOL issues. Cases in point: the DOL did consult with the IRS about the Delinquent Filer Program but it also said so--and then the IRS specifically came out with its own announcement that it would accept the DOL program. Also, the IRS did discuss the ERISA-covered plan issue in the preamble to its 403(b) regs and indicated that it had discussions with the DOL, but it was the DOL which then came out with an FAB to discuss the issue from the DOL's perspective. Here (preemption of state payroll practice rules), there's no indication any such discussions between the IRS & DOL took place, and I don't think the DOL has spoken on the issue.

QDROphile - Of course "commercial lenders do not make loans with optional payment", but, in fact, the payment is always optional because the borrower can cease to make payments at any time. Then, the commercial lender either defaults the loan and takes the collateral or sues. it cannot force the employer to garnish wages without a court order.

Now, if we assume that there is NO preemption of state payroll laws, on what basis can anyone--employer or plan--prevent the cancellation of an agreement to withold? That is the right of the employee. Anyone can break a contract--even an employee who promises to authorize payroll withholding--but there are consequences to breaking a contract. If an employee breaches the agreement to payroll withhold, there is a consequence--default of the loan (assuming, of course, that the loan documents indicate that cessation of payroll withholding is, in fact, considered a breach of the agreement). Plain and simple. And this default entails deeming a distribution, and its tax consequences--and the continuing impact on future loans. As GBurns points out, the employer is not a party to the agreement, but simply agrees to payroll withhold when the employee asks that it be done--and to cease payroll withholding when the employee tells the employer to cease. If there is no preemption, then this is no different than giving an employer the right to force payroll withholding on an employee's pay if the employee's dentist tells the employer that the employee has not followed up on his/her obligation to payroll withhold to pay a bill--and that would not be allowed in most (all?) states. You cannot force someone to do or not do anything, contract or not, without an injunction. Even if we assume the employer here is a fiduciary (which I think it is not when it's wearing its employer hat), how can it be a fiduciary breach for the employer to cease doing something that it cannot, under state law, do without the employee's permission?

On the other hand, if you believe state payroll laws are preempted by ERISA, then maybe you can force the employee to continue to payroll withhold. However, notice that it took Congress to settle the preemption issue surrounding auto-enrollment, even though the DOL had opined that there was preemption on that issue a number of years ago. I don't think this issue is settled, by any means. But, I can't currently see the employer forcing payroll withholding on an employee, nor do I see a way for the plan administrator to force the employer to do so.

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Under bankrauptcy law a plan loan is a not a debt that is subject to discharge and a participant cannot request that the court issue a restraining order to prevent the loan from being withheld from the employee's pay check. So why should the rules be different in a non bankrptcy case?

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Guest Sieve

This is a preemption issue. The applicablility of federal bankruptcy law to a plan loan has no bearing on the applicability of a state law regarding payroll practices to a plan loan. ERISA does not preempt federal law. ERISA may or may not preempt state law. If ERISA doesn't preempt state payroll practice laws, then the state law will prevail--no matter what the bankruptcy rules are.

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This is a preemption issue. The applicablility of federal bankruptcy law to a plan loan has no bearing on the applicability of a state law regarding payroll practices to a plan loan. ERISA does not preempt federal law. ERISA may or may not preempt state law. If ERISA doesn't preempt state payroll practice laws, then the state law will prevail--no matter what the bankruptcy rules are.

[/quote

Yes, we all know that ERISA does not preempt federal law. My response was intended to convey the congressional policy of not interfering with plan loans so as to prevent adverse tax consequences to plan participants which result from defaulting on repayment of a plan loan.

As for preemption of state payroll practice laws, I thought it was understood that state laws are preempted if they interfere with the uniform administration of a plan. For example, see Boggs v. Boggs, 529 US 833 (community property) and Egelhoff v. Egelhoff 532 US 141 (removal of ex spouse as beneficiary). If a state law limiting the amount of pay that a participant can elect to defer is preempted then why isn't a state law that requires employee consent to continue reduction from pay preempted?

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mjb: I think the concern (if there is one) is that the criminal law aspects of state wage laws might not be preempted due to the "generally applicable criminal law" exception in Section 514. On the other hand, it would be sort of comical to imagine a state atty general or other law enforcement agency going after an employer or its principals for refusing to stop payroll deductions used to repay a plan loan to the employee's own account.

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