Leaderboard

You said, "reversions are not an option when handling the distribution of residual assets. Instead, the Plan says any excess should be allocated among participants". Assuming that is true, then I agree with the attorney and you can't use a QRP. A QRP is essentially a reversion to the employer, which your client's document does not permit. You can change this wording, but it can't be effective for 5 years. The excess assets need to be reallocated to the participants, and cannot be reverted to the employer. A QRP is an employer reversion since it essentially reduces the cash the employer would have contributed on future DC allocations.

I would also recommend either eliminating loans OR allowing loans for any reason. Other choices baffle me.

@fmsinc I have several clients who do not permit loans for any reason and three who do not permit loans except for hardship circumstances. These clients are very paternalistic and believe that the 401(k) funds are for retirement and should not be used like their bank accounts. All of these clients provide generous matches and profit sharing contributions. At least two of the three who permit the loans would be seriously upset at someone who would take a loan under false pretenses. Both of these clients would have no issue causing a participant (especially if the participant was one of their union employees) "financial grief" because they would worry that the participant who took the loan under false pretenses would tell others "how easy it is" to do.

In the original post, the plan sponsor is willing to give the participant until the end of the year to remedy the situation. This does not sound like a plan sponsor who wants to punish the participant, but does want to enforce the terms of the loan policy. The plan sponsor likely is willing to help the participant work out a solution that does not impact the plan. If the plan sponsor has lost all faith in the participant's word that it can no longer be trusted, then they likely would terminate the participant's employment. The plan sponsor does need to enforce the rules lest work get out that anyone can lie and take out a loan for any reason without consequences. This just as easily lead some participants to think other plan or company rules where lying will not have consequences. Or, the plan sponsor could acknowledge that restricting loans is no longer a good idea and remove the restrictions. That is the plan sponsor's decision. Plans should communicate in writing how the plan will operate, and then operate the plan accordingly. Put in more common language, plans should say what they will do, and then do what they say. Any teacher or parent can tell you that anything else is asking for trouble at some level.

Agree with Effen and truphao. I think says more that participants don't have to get excess unless plan says so, or its reversion provision wasn't old enough. 7.12.1.17.1(2)c says: "Establish a qualified replacement plan per IRC 4980(d). Follow the processing procedures in IRM 7.12.1.17.1.2 (5), Reversion of Excess Assets." I think that also seems to indicate that IRS views transfer to a QRP like a reversion from the perspective of plan provisions. If you look at pre-approved plan language, the options are allocate to participants or revert to employer, so transfer to a QRP needs to fit under one or the other, and it has to be reversion.

Let me see if I understand. You have a policy which is not part of the plan documents that limits a participant's right to borrow his own money from his own 401k account to a limited number of circumstances. Your participant borrowed money on one pretext, but used the money for another non-permitted purpose but is faithfully making the repayments. And your policy is to cause this participant financial grief, thereby ensuring his future love and affection for his employer?

The reality is that the participant is borrowing his own money and will pay it back to himself with interest. It is not a "loan" in the classical meaning of that word. It is more akin to taking $20 out of the cookie jar in the kitchen on Monday and paying $21 back on the following Monday. A promissory note is a legal instrument under the uniform commercial code and carries with it all sorts of rights, duties and obligations that seem out of place in your situation. I agree with Peter that all you need is some written acknowledgment of the obligation to repay the money. And that isn't even true if The participant decided to terminate his employment and turn the "loan" into a taxable distribution.

I have no argument about use of a promissory note as best practice. A promissory note is a device that facilitates enforcement/collection as a matter of civil procedure. It is not essential for creation of a valid, enforceable obligation to pay. As suggested by Lucky32, it is taken for granted in commercial lending practice, which is the standard for plan loans. So why would a fiduciary not employ one?

You may want to suggest to the employer to look into how the contributions were handled on the company's tax return and how the IRA provider reported the contributions to the employee. If the employer took a deduction for the contribution and the IRA provider reported the contribution to the employee as a deductible contribution, then the contribution could have been deducted on the employer's tax return and on the employee's tax return. If this did happen, emphasize that this is just a question and for the sake of maintaining sanity, keep repeating to yourself either "not my farm, not my pig" or "not by circus, not my clowns".