loan repayments different from sources taken from

[DMcGovern]

I haven't seen this before, but I'm hoping it's not a problem.  This is for a large 401(k) plan that is administered by a major payroll/benefits company.  The funds for new loans are withdrawn from several sources, no problem with the amounts taken.  The loan repayments are what I'm questioning.  In most cases (if not all) for the repayments, principal is only applied to one source - the profit sharing source.  No principal is applied to deferral, roth or safe harbor match until the loan balance in the profit sharing source is paid in full.  For example, a participant took a $3200 loan - 75% from the deferral source, 12% from the safe harbor source, and 13% from the profit sharing source.  The payments show that only interest is credited back to the deferral & safe harbor match sources and the profit sharing source is credited with all the principal repayment and some interest.

Is this ok?  I have only seen repayments applied back in the same manner as they were withdrawn.

Thanks!

[CuseFan]

22 hours ago, DMcGovern said:

administered by a major payroll/benefits company

This was the first clue that something crazy was happening, as they do what's easiest for them. I'll repeat this forum's mantra - read the plan document and the loan program and related forms to see if they say anything applicable, they may or may not, but should be consulted first. Next question would be how are the interest payments being applied, is it in such a manner that each "source loan" is essentially being amortized separately (less interest into PS as that principal is paid down and more to the sources yet to see principal payments)? If so, and if the plan documentation supports (or does not prohibit) this then it's probably OK. Also need to make sure provisions concerning loan as directed investment (I assume) and general plan investment election provisions are not being violated by this in some fashion.

[Mr Bagwell]

if the loan went full term the sources would get the appropriate principal and interest?

[Lou S.]

 I don't think it's a problem as long as all sources are repaid in the end. They probably want to repay any source that might be subject to vesting first to limit the chance for messing up the vesting if the loan goes into default or is off set.

[DMcGovern]

Thanks for the replies!  I checked the loan policy, it does not address how payments are applied.  Adoption Agreement just allows for loans.  All sources are 100% vested, so vesting is not an issue here.  The participants are allowed up to 4 loans (ugh!) and many of them have more than 2 loans.  I guess this isn't a problem in the end, it's just different.

Thanks again!

[Bill Presson]

The basic plan document may have info on how the payments are applied. Vesting is just one of the issues with the repayments. Distribution timing would also be affected.

[DMcGovern]

Thanks, Bill!  I did check the basic plan document as well.  It doesn't address how loan payments are applied to sources (or anything on payments at all).  I was concerned that these repayments would affect funds available for hardship or in-service withdrawals.  Those are not allowed until age 59 1/2 so I think the distribution side of things is ok? 

[Bri]

I wonder if it was just that their recordkeeping software was coded as "source hierarchical / funds pro rata" or something like that for the repayments.

[Hello]

I saw this on a plan like 20 years ago.  Check to ensure that the distribution options are the same for the money sources.  If in-service distributions (or hardships, etc.) are only permitted from salary deferrals, repaying the loan to the profit-sharing bucket will impact that.

[Paul I]

There are a few other places to check, too.  What does the SPD say?  If there is a separate loan policy, if so what does it say?  What does the loan application or description of the loan provisions on the web site say?  Is there anything in the promissory note (less likely) that says anything?

In the method being used, the interest is going back to the original source, but all of the principal is going into the profit sharing source.  In effect, the method is accelerating the repayment of the loan principal that came from the profit sharing source and which reduces the total interest the profit sharing source otherwise would have received if the principal was being repaid concurrently across all sources.  The other sources wind up with more interest than otherwise would have been paid if the principal was being repaid concurrently across all sources.

The gist of most of the comments is that each source has different BRFs, so is this an issue?  The answer often boils down to "it depends".  For example, it depends on availability of the funds for in-service withdrawals, or vesting schedules among sources (e.g., NEC versus match).

Generally, if the perspective is the loan is an investment option available within the source, and interest on loans is the return on that investment, then this method is counterintuitive. 

I have seen many different schemes for recordkeeping loan repayments but have not heard of either the IRS or DOL challenging any of them.

Follow the plan's documentation, collect regular loan repayments, stick to the amortization schedule, and be consistent on how the repayments are posted.

[Bird]

I suppose it sorts out in the end, if the loan is in fact paid off, and the sources get repaid in full. But in the interim, there are vesting issues, also possible issues with availability of funds at different times for different sources. I can't see how this is "ok" but I also doubt anyone (else) would pay enough attention to cause a scene; not that I wouldn't love to see a major payroll/benefits company learn a lesson in how things need to be done correctly.

I seriously doubt this is covered in any SPD, BPD or other documentation. It should be implicit that money from a source goes back to that source.