Fronting Loan Or Distribution Proceeds

[Disco Stu]

I can't put my finger on this one, but it smells bad to me. I'm hopeful someone can clarify this issue for me.

I have a client that wants to front the proceeds of a bona fide participant loan to a participant. They'll cut the individual a check now. When the loan check arrives from the trust, the participant will sign over the check to the employer.

I want to say that the fronting of the money to the participant is a prohibited transaction, but am not sure. Anyone have anything specific they can point me to?

Thanks.

[mbozek]

There is an interesting question of whether the loan check is a plan asset until it is cashed. Under case law once a check is cashed by a participant it is no longer plan assets, e.g., proceeds can be seized by creditors of the employee. Secondly is this transaction between the plan and a disqualified person because the check is drawn on the plan's account or is it a transaction between a participant and a disqualfied person because the check is payable to the particpant??

The question is whether endorsement of the check to the employer is a transfer of plan assets for the benefit of a disqualified person (employer) under IRC 4975©. Would u feel better if the employee deposited the check from the plan and wriote a check from his/her personal checking account?

[actuarysmith]

I share Disco Stu's concern. Isn't the employer making the short tem loan on the assuption that the forthcoming loan proceeds from the plan are collateral?

I know this may be getting technical, but until the loan is released, the funds are still part of the plan. They cannot be used as collateral against a loan.

I know this doesen;t specifically answer DS's question, but it is another angle from which to look at the issue.................

Also, would the employer be willing to do this for any employee taking a loan from the plan? Does this set a precedent? Could another employee claim discrimination if they also needed the funds in a hurry and the emloyer made them wait for the check from the plan?

[Fredman]

I'm not so sure this is a PT. If its done outside the plan why would it be a PT? The company is borrowing this guy some cash...maybe an advance on is salary. Instead of not receiving a paycheck for the next three months, he decides to pay back the company with a loan from the plan.

Same scenerio, but the guy goes and gets a loan from a bank and pays the company back, then gets a loan from the plan to pay the bank back.

I think if they allow the participant to cash the loan check and the participant hands them the cash from the loan check then its ok. Maybe the company needs to send "Brutus" to the bank with the participant to make sure they get paid, but I don't see how this could be considered a PT.

Maybe I'm wacko, but if a client wants to start loaning money to people, so be it, but I'd advise that its best to leave that to a bank.

[Kirk Maldonado]

Fredman:

You may be wacko (I don't know one way or the other), but your position on this issue isn't. I concur in your view.

[Disco Stu]

Fred or Kirk,

Would your opinion of the situation change if instead of cashing the check and handing over the proceeds, the participant simply signs the check over to the employer?

I the end, this is form vs. substance, but would you be nervous about the form in this case?

[Guest b2kates]

Simply signing over the loan check smells really bad.

Was the loan truly to the participant or a disguised PT loan to the employer.

I can understand the employer trying to be nice, but many times that is what gets an employer in trouble.

Conceptually to advance the loan subject ot payment upon receipt of the loan check could be construed to be an impermissable assignment of plan benefits.

Best advice do not do it.

Brett

[mbozek]

b2kates: I thought that under the non alienation rules of ERISA a participant could voluntarily assign payments to any third party, including the employer if the recipient files a notice with the plan admin acknowledging the voluntary nature of the assignment. Why is a loan different?

[Guest b2kates]

very specific limited exception permits the assignment, not more than 10% of the distribution may be voluntarily assigned.

[Fredman]

I agree with Brett's statement...

"Was the loan truly to the participant or a disguised PT loan to the employer. "

...especially if the participant signs the check over to the ER. In this case, it does look like like a PT.

I think though that if the participant cashes the check and hands the ER the money that it would be extremely difficult to uncover in audit. I think you might be able to argue that its still a PT, but no harm no foul.

I also agree that its best to stay away from these types of transactions.

[mbozek]

b2kates- not true see reg. 1.401(a)-13(e). Any portion of benefit can be assigned....to an employer

[Guest Bud]

We've done this many times, usually in M&A circumstances where the acquired company's plan is merging into our plan and there is a blackout period. We don't consider this a PT. A couple of the M&A plans were audited a couple of years after the merge and it wasn't an issue.