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Participant wants to cease payroll withholding and default on loan


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401(k) Plan.  Loans per loan policy repaid through payroll withholding.  Participant going through divorce and wants to cease the withholding for loan payments and default.

Prior threads (found one from 2008) show no guidance offered and I have not found any guidance.

Any thoughts would be welcomed.

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If the terms of the plan (which include the loan policy) and the terms of the loan allow for the participant to cease payroll deduction and cause the loan to default, the fiduciary will have breached its duty with respect to issuance of the loan.  A loan cannot be made without a reasonable expectation that it will be repaid.  A payroll deduction arrangement is a good mechanism to assure repayment,  but not if it allows the borrower to elect to render this he arrangement ineffective.  If there is no impediment to a borrower's discretion to repay, there is no commercially reasonable expectation of repayment.  Lenders are not supposed to be a trusting lot.

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My understanding is there are laws in many/most states that say an employer cannot take a non-governmentally required deduction from an employee's pay without their consent and by implication the consent can be revoked.

These laws are probably not preempted by ERISA so we advise that employees can revoke their agreement to make loan repayments at any time.

There's a recent thread discussing the issue of the consequences of the PAs actual knowledge at the time the loan is made that the participant intends to default.

 

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Just wondering if there is any chance that the proposed action would constitute a fraud against the soon to be ex-spouse.  Seems to me that if it would, it should be avoided if at all possible.  Couldn't the plan administrator be held to have an implied fiduciary duty to the soon to be ex-spouse?

Always check with your actuary first!

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If the terms of the plan (which include the loan policy) and the terms of the loan allow for the participant to cease payroll deduction and cause the loan to default, the fiduciary will have breached its duty with respect to issuance of the loan.  A loan cannot be made without a reasonable expectation that it will be repaid.

Don't understand how just the ability to cease payroll deductions is inconsistent with having a reasonable expectation that it will be repaid.  Nobody said this was a sham from the get-go.

Ed Snyder

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2 hours ago, My 2 cents said:

Just wondering if there is any chance that the proposed action would constitute a fraud against the soon to be ex-spouse. Couldn't the plan administrator be held to have an implied fiduciary duty to the soon to be ex-spouse?

From the facts in the OP, it does not appear that a the plan has received a QDRO.  And a divorce does not necessarily mean there will be a QDRO at all.  Without a QDRO the PA does not owe a duty to a current participant's soon to be ex-spouse.  

 

 

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If you do not like your fiduciary breach up front, you get another chance when the fiduciary is faced with a decision about whether/how to collect the overdue payments.  The fiduciary cannot ignore management of plan assets and must take reasonable steps to maintain plan assets.  If the participant has an income, it is not an automatic decision that it is not worthwhile to pursue collection.

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3 hours ago, QDROphile said:

If you do not like your fiduciary breach up front, you get another chance when the fiduciary is faced with a decision about whether/how to collect the overdue payments.  The fiduciary cannot ignore management of plan assets and must take reasonable steps to maintain plan assets.  If the participant has an income, it is not an automatic decision that it is not worthwhile to pursue collection.

I've had some interesting discussions over the years (decades) about this.  IF the participant/borrower is employed and capable of paying back the loan, would not the fiduciary be *required* to enforce the terms of the loan (arguably obtaining a judgement and then garnishing the wages of the defaulting participant)?  I can't say I've ever seen it done for a participant loan (but have seen it done when loans were unallocated plan loans).  One could even argue that it might be more prudent for the plan fiduciary to sell the plan loan to debt collector.  Whatever the discounted amount received may in fact be the most prudent course of action.

Just food for thought, and not necessarily advocating for such an approach....

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All interesting responses and based on my review and discussions there is a lot of disagreement.  I agree that this could be an issue with plan operation.

Our policy in the past has been once the Plan Sponsor becomes aware of a divorce proceeding any unusual transaction needs to be scrutinized and in some cases have required the participant to obtain approval of loans, distributions, etc.  I understand that this goes beyond the rules but has avoided issues down the road.

Thanks to all.

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In IRS / DOL reviews in the past I have never encountered an issue regarding pursuit of loan collections.

Exactly.  I agree that it doesn't make it right, but at the same time you have to have some sense of practicality. 

When you think about, you can have a payroll department that has absolutely nothing to do with plan operation, other than feeding withheld money to it.  The plan fiduciary doesn't necessarily have control over that operation, and certainly can't override instructions the employee gives to that department.  And to fail to approve a loan because they don't have absolute control to force repayments is not justified.  The fact is that loans default, all the time, and we have lots of guidance on how to handle them.  The only defaults I'd be concerned about are those that are a sham from the beginning, with no real intent to repay.

Ed Snyder

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You need a new policy concerning discovery of a participant divorce.  The law is quite clear about requirements and limitations relating to divorce proceedings and documents.  For the most part, the plan cannot interfere with participant rights and privileges.  The plan is required to act in a specified manner on receipt of a domestic relations order and otherwise is inviting trouble by getting involved.

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16 minutes ago, TPA Bob said:

All interesting responses and based on my review and discussions there is a lot of disagreement.  I agree that this could be an issue with plan operation.

Our policy in the past has been once the Plan Sponsor becomes aware of a divorce proceeding any unusual transaction needs to be scrutinized and in some cases have required the participant to obtain approval of loans, distributions, etc.  I understand that this goes beyond the rules but has avoided issues down the road.

Thanks to all.

First time posting from my phone since the new format was rolled out so here we go :)

 

TPA Bob,

Is your firms policy the same as the PLANS written policy?  Do they match?  If not, that could be a big problem. 

What does "becoming aware" of a divorce mean?  Does it have to be in writing?  Can it be an office rumor?  I'm not trying to be difficult, but when I hear about policies like this I wonder if the PA understands how much responsibility they are taking on in deciding whether to suspend participant rights without anyone even mentioning the word QDRO...

 

 

 

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8 minutes ago, QDROphile said:

You need a new policy concerning discovery of a participant divorce.  The law is quite clear about requirements and limitations relating to divorce proceedings and documents.  For the most part, the plan cannot interfere with participant rights and privileges.  The plan is required to act in a specified manner on receipt of a domestic relations order and otherwise is inviting trouble by getting involved.

Thats what I was getting at but you beat me to it.

 

Well said Sir.

 

 

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Sorry for opening a can of worms.  Two events.  When we receive a "draft" of a QDRO to review before it is provided to the court for approval or when someone in ownership or a fiduciary to the Plan is going through a divorce we proceed with extreme caution.  Understand everyone's concerns and will be more aware going forward. 

For the most part we never become aware until the QDRO is received.

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Sorry for opening a can of worms.  Two events.  When we receive a "draft" of a QDRO to review before it is provided to the court for approval or when someone in ownership or a fiduciary to the Plan is going through a divorce we proceed with extreme caution.  Understand everyone's concerns and will be more aware going forward. 

For the most part we never become aware until the QDRO is received

 

We are the same as you.  Once we are aware of a divorce, we use extreme caution in any possible transactions regarding that participant..

 

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"Use extreme caution" does not have much meaning.  How about "understand the law and follow it"?  Despite the the incorrect informal position of the Department of Labor, receipt of a draft domestic relations order is no basis for restricting rights of a participant unless the written QDRO procedures expressly provide otherwise and specify exactly what happens on receipt of a draft.

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4 hours ago, QDROphile said:

"Use extreme caution" does not have much meaning.  How about "understand the law and follow it"?  Despite the the incorrect informal position of the Department of Labor, receipt of a draft domestic relations order is no basis for restricting rights of a participant unless the written QDRO procedures expressly provide otherwise and specify exactly what happens on receipt of a draft.

It means exactly what it says.  I know the law, I am an Actuary with over 35 years experience.  Knowing the law is important but how you apply it is the issue.   

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You either have a QDRO or you don't.  You either have a situation where the plan's written procedure dictates that the participant's rights are restricted or you don't.  There should be no gray area here. The written procedures should spell out exactly what has to happen in order for a participant's rights to be restricted.  The law balances the rights of both beneficiaries and participants, and that balance should be upheld.  This is not an issue where the PA should consider facts and circumstances. 

Does anyone in this discussion actually have plan procedures that allow for a participants rights to be restricted solely because the PA has been made aware of a possible or pending divorce?  

 

 

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1 hour ago, RatherBeGolfing said:

Does anyone in this discussion actually have plan procedures that allow for a participants rights to be restricted solely because the PA has been made aware of a possible or pending divorce?  

Yes....  We have a QDRO procedure provided by us that is used by our clients (plan sponsors) that says the plan FIDUCIARY *may* impose a 90 hold on participant withdrawal right with reasonable knowledge that a DRO *may* be issued.  I believe the language originally came from our document vendor.

No one is aware of the 90 days ever being imposed, and we have been discussing the pros and cons of having such "permissive" language in the procedure - especially since if implemented, 1) you could/would have an angry participant; 2) you would have to police it to see that it was timely removed; and 3) if you remove it and DRO subsequently appears (after the account was cleaned out), you would have an angry alternate payee.

Three strikes.  It may be removed going forward - even though the document makes this a plan FIDUCIARY responsibility (of which we are not).  Plan FIDUCIARIES have this nasty tendency to point fingers at service providers (especially if you provide them with a document that says such things can be done).

To be honest, we see two scenarios 99.9% of the time.  Most, the plan sponsor is totally unaware of the pending divorce till the (bitter) end.  Some (but a growing number - especially for California participants) name the service provider (not the plan - because except for a DRO, the plan can pretty much ignore the court under ERISA preemption) as parties to the divorce action and then are automatically enjoined from distributing participant balances pending further order of the court.

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"Some (but a growing number - especially for California participants) name the service provider (not the plan - because except for a DRO, the plan can pretty much ignore the court under ERISA preemption) as parties to the divorce action and then are automatically enjoined from distributing participant balances pending further order of the court."

Mojo - can you educate me a bit on this? What are the requirements for validly "naming" someone as a "party" to a divorce action? If the service provider has no discretionary authority, then would it have any actual effect regardless of whether they are named or not? If there is discretionary authority, then wouldn't the service provider be a fiduciary, which is generally what we seek to avoid at all costs! I'm not a lawyer, and I really have no idea what the intricacies are...

Thanks.

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11 minutes ago, Belgarath said:

Mojo - can you educate me a bit on this? What are the requirements for validly "naming" someone as a "party" to a divorce action? If the service provider has no discretionary authority, then would it have any actual effect regardless of whether they are named or not? If there is discretionary authority, then wouldn't the service provider be a fiduciary, which is generally what we seek to avoid at all costs! I'm not a lawyer, and I really have no idea what the intricacies are...

Thanks.

The intricacies of joining one is a matter of "Rules of Civil Procedure" and those are state based.  I'm not licensed to practice in CA and have no clue what their rules provide.  In places where I have practiced, it is legit to join as a party one who has possession of "marital assets" to be able to restrict asset disbursement during the divorce proceeding.  In the past, the plan itself has been named (and I've worked for service providers that also provided trust services to the plan) but we were successful in being dismissed as a aparty under ERISA preemption issues.  Hitting the service provider (non-fiduciary) with being named as a defendant and then being enjoined from disbursing assets is a new one to me (relatively), but in the 8 months I've been with my current employer, I've seen a number of cases out of CA that do so.  I do know that for some CA domestic relations courts (the ones where my employer has been served) it is a perfunctory process using fill in the blank forms that essentially identify us as a service provider having "control" (not discretion) over plan assets, and it immediately enjoins us from processing any distribution or alienation of the participant balance without further order of the court.  In essence, we don't need discretion to be prevented from "pushing a button" or writing a check."  The injunction is not against the plan or it's assets, it's against us (as service provider) from doing anything that could impair the marital asset,  until it's ultimate disposition can be determined  I couldn't tell you what would happen if a plan fiduciary directed that plan assets be distributed - it hasn't happened, but I can tell you that in order not be held in contempt of court, we would notify the court, and figure out the rest later.

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3 hours ago, MoJo said:

Yes....  We have a QDRO procedure provided by us that is used by our clients (plan sponsors) that says the plan FIDUCIARY *may* impose a 90 hold on participant withdrawal right with reasonable knowledge that a DRO *may* be issued.  I believe the language originally came from our document vendor.

No one is aware of the 90 days ever being imposed, and we have been discussing the pros and cons of having such "permissive" language in the procedure - especially since if implemented, 1) you could/would have an angry participant; 2) you would have to police it to see that it was timely removed; and 3) if you remove it and DRO subsequently appears (after the account was cleaned out), you would have an angry alternate payee.

Three strikes.  It may be removed going forward - even though the document makes this a plan FIDUCIARY responsibility (of which we are not).  Plan FIDUCIARIES have this nasty tendency to point fingers at service providers (especially if you provide them with a document that says such things can be done).

To be honest, we see two scenarios 99.9% of the time.  Most, the plan sponsor is totally unaware of the pending divorce till the (bitter) end.  Some (but a growing number - especially for California participants) name the service provider (not the plan - because except for a DRO, the plan can pretty much ignore the court under ERISA preemption) as parties to the divorce action and then are automatically enjoined from distributing participant balances pending further order of the court.

Very interesting.  That is a little too much discretion for me to be comfortable (may impose / reasonable knowledge / may be issued) but thats just me.  Im curious about the California cases...  Do they present any issues or implications for you as a service provider, other than being enjoined from distributing participant balances?  

 

 

 

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