no spousal consent

[stevena]

401(k) Profit Sharing Plan has loans allowed if for certain reasons...purchase of home is one.

Employee took out loan, did not purchase home. EE signed loan request form which indicated his reason for loan was "purchase of home"

also spousal consent was not received and we just found out that ee is in midst of divorce

can anyone cite the correction for this? ee is refusing to return money to plan, spouse is refusing to sign.

thanks

[rcline46]

Lets take simple answer. EE committed fraud. Trustee files suit for fraud against ee. Otherwise plan has problems due to impermissable distribution.

Also if amount is over $5000, required spouse signature if annuity options in the plan. Possibly if no annuity options not required but I have never checked that out.

[stevena]

Thanks.....

The loan is 20k and plan document requires spousal consent on loans specifically.

Whole situation is bad.

Any remedy that is proposed by DOL? Someone told me something like the employee had fifteen days to respond to some kind of notice we are required to give them, asking them their intentions basically, and if they did not return it we were to assume that they had no intention of returning money or getting consent.

Then, they said the plan had two years to fix the problem and if not the plan was required to purchase an annuity for the spouse in the amount of the distribution.

Did you ever hear of this? I cant find it anywhere...and have spent hours looking....

thanks for your help.

[david rigby]

What kind of employee? HCE?

You are right, this is a bad situation. If HCE, very bad. If owner, very very bad.

Sounds like the EE might be trying to keep funds away from spouse. I'll bet the judge will have something to say about this. The plan's best hope might be that his divorce attorney will let him know the meaning of "fraud".

[stevena]

No, just a rank and file guy. No owner or HCE.

But it is very very bad because it is my case. Bummer.

But is the trustee really required to pay up for the mistake, do you know? Have you ever heard of this?

[Kirk Maldonado]

Tell him that unless he repays it within 48 hours, you will issue him a 1099-R indicating a distribution. Also, remind him that he not only has to pay the income tax on the amount of the distribution, but the 10% premature distributions tax as well. That may persuade him to return the money. I've seen it work before.

[stevena]

We thought of that, but aren't we then making the situation worse by issuing an illegal distribution? Then the funds are not even a plan asset anymore....which we thought might be worse? Then we are issuing a distribution without spousal consent which is sort of getting us back to the same place.....

we were thinking as long as it was a plan loan, the employer could at least put the money back into the plan (eventually) by the forced payroll deduction loan repayment.

Then again, if we issue it as a distribution at least we are taking some action...

Anyone have any opinions either way?

[Disco Stu]

I'm in agreement with your last post...the lack of spousal consent makes this a very difficult spot. Maybe this isn't an option, but I think the cleanest of the clean responses to this is to have the trustee pony up the dough to make the participant's account whole. Then they could pusue collection on their own, outside of the plan.

If the spouse's attorney is sharp, the trustee may end up on the hook anyway...depending on the division of the assets. This has happened in other similar situations where a plan benefit was paid to someone other than the rightful beneficiary or alternate payee.

I'm not sure you can force the salary reduction agreement on the employee. If the participant agreed to the salary reduction in the loan note, you'd have stronger footing, but in general if the participant wants to put up a fight, I'm not sure you can force the repayment via salary reduction.

[stevena]

Thanks for the replies!!

Salary reduction is the only allowable form of repayment in the document. It also says it on the promissory note, which of course is not signed (spousal consent is part of the prom note which we have not received back. Participant basically will not return the promissory note. So we dont even have his signature.)

What I am questioning is if the above post reference to the 15-day, 2 year deal is correct (and I cannot find a reference to that cite anywhere!!) than do we have the authority to change the terms of the loan to a 2 year loan. Even though the (unsigned) promissory note made it a 5 year loan.

Trying to avoid having the trustee cough up 20 grand.....

[Tom Poje]

you indicated plan was 401(k). this probably means there is no QJSA rule, and therefore spousal consent is not necessarily required.

see IRC 417(a)(4) which refers back to 401(a)(11)

now it might be possible the loan policy for the plan requires it, but you didn't indicate that.

[Disco Stu]

Not sure about the 15 day reference, but the 2 plan year thing could be referring to the EPCRS program which allows for self correction of operational errors. If I'm remembering right, insignificant operational errors can be self corrected at any time. Significant errors can be self corrected within two years.

Keep in mind though that if the IRS or DOL catches the problem before you fix it, that you don't get to use self correction.

If you haven't done so, you might check through the Q&A columns on BenefitsLink. You might find some other recommendations in there.

[stevena]

Thanks,

We checked the document and it does require spousal consent on loans in the loan provisions.

I found out the following this morning:

1) That this is an operational defect that is qualified as "insignificant"

2) That the remedial correction time is the last day of the plan year following the year in which the correction occurred.

3) that the required correction is to obtain consent (not gonna happen), get money back in the plan, or the plan sponsor pays up to purchase an annuity for the spouse.

OK....so....here is the question. What if we change the repayment (which is required by the document to be payroll deducted) so that it will be paid off by the time the remedial correction time is over. That way money is back in the plan by the end of the correction period.

Now, the promissory note which we drafted for the employee lists a five year repayment. Does the sponsor have the authority to just change that to two years. Mind you the participant never signed the promissory note.

[Disco Stu]

You proposed solution is problematic (by my way of thinking) for two reasons.

1. Even though in theory you can self correct this, in your case you won't have corrected until two years from now. The trustee has his/her pants down for this entire two year period. In the IRS' view, the problem isn't corrected at all until it is fully corrected.

2. Without a signature from the participant agreeing to the salary reduction, I still think you'll have trouble forcing it on him. Especially if he's in a fighting mood.

Another thought I had on this...isn't this a prohibited transaction?

Essentially, IRC 4975 says that all loans are prohibited transactions unless they fall under the excetions that are listed. The fact that you don't have any loan documents or promise to pay, makes me wonder if you need to declare this as a PT.

If you do that, you increase the likelyhood that the IRS will find their way to this client's door within the next two years.

[david rigby]

As near as I can figure this out, the participant did three things wrong: not getting spousal consent as required, not using the money as he promised, and not returning the promissory note.

But the plan administrator did (at least) one thing wrong: giving the money to the participant without the plan requirements (consent, promissory note) being completed. Sounds to me like the administrator needs to lean on the EE, but PA may have to admit fault as well.

[Kirk Maldonado]

Would the prior commenters explain how somebody can take a distribution from a plan and not be taxable on it (meaning that you don't have to issue them a Form 1099-R)? If you can do that, you have just come up with the best tax saving technique that I've ever heard of!

Stated in a different fashion, how does the trustee (or anybody else, for that matter) contributing the money to the plan (to make the plan whole for the mistake) eliminate the distribution that the individual received? If that worked, then the President of the Company could take out a million dollars, contribute another million dollars to the plan (which would be deductible under Section 162), and not be taxed on the amounts he took out.

Does anybody really believe that works?

Also, whether or not the distribution was proper should not have any impact on taxability. It is taxable. Now whether the person would get a deduction for the repayment, that is a completely different question.

[rcline46]

Stevea - how did the $ get distributed without a signed form? As a TPA, we will not permit any liquidations until we have signed paperwork. Of course we cannot stop a client from bypassing us.

Was a broker involved who just liquidated and sent the money without trusttee orders? Then you have yet another party involved!

Also, as a loan, it is still in the account balance, so it cannot be 'hidden' from the spouse anyway.

[Disco Stu]

In reponse to Kirk, I don't think that I disagree with giving a 1099 to the participant that received the money. If there wasn't the problem of the lask of spousal consent and the continuing unwillingness of the spouse to consent after the fact, I might be inclined to agree that the 1099 would be the end of the discussion.

Given the facts and the possiblity of an impending QDRO, the trustee may have larger problems than just making the bogus loan taxable.

In the Q&A columns, #'s 88-90 discuss possibilities for dealing with the lack of spousal consent. There is some discussion in there of the previously mentioned annuity. That approach would likey be more pallateable to the employer than the restoration of the account balance that I suggested.

[Kirk Maldonado]

I agree with Disco Stu that there are much bigger problems than the Form 1099-R.

It just seemed to me that everybody was ignoring that aspect of an ugly situation.