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QDRO - loan


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How are people handling QDRO's when there is an outstanding loan in the participants account? The alternate payee does not want the loan responsiblity. Example: alternate payee is awarded 60% of total account balance. Account contains 50K in cash and a 50K note(loan). What langauage protects the alternate payee so that when the loan is paid back, the alternate payee receives the payments. What happens if the participant defalults? Any protections?

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Alternate Payees should be careful what they ask for. The loan is an asset of the account. If the QDRO does not specify that the AP's interest excludes the loan, the plan should follow its own rules about how to allocate assets to the AP (I suggest that the plan's written QDRO procedures provide that unless the QDRO specifies otherwise, the AP's interest will be created from assets other than the loan, to the extent possible). If the AP's interest includes all or part of the loan (because not enough other assets are available or for other reasons) the AP gets the results of the loan rules. If the loan defaults and is either deemed distributed or is offset in a distribution, the AP gets the AP's proportion of the taxable income (but no cash). The plan should prevent the AP from getting a distribution of the loan asset (or the AP's share of it) until it is paid. Upon full payment, the AP's interest is held in other assets and is ready for distribution. No particular language is necessary to get this result, and the plan has no responsibility to make sure the loan gets repaid other than to administer its loans properly (which could involve foreclosing on security). The domestic relations court court could order the participant to pay the loan, but that is betwen the court and the participant. Ultimate payment to the AP is a result of the AP having an interest in the loan that gets paid back. The plan could have rules for apportioning each loan payment between the AP's interest and the participant's interest in the loan (pro rata is standard). Many of these issues would not be so difficult if domestic relations orders were more intelligently thought out and drafted, but that would be too much to expect. An interesting question for someone else is whether a plan can give the AP an opportunity to pay the outstanding balance on the AP's share of the note, or otherwise allow the AP's interest in the debt to be retired in advance of the remainder of the debt. I see no problem if the AP has a 100% interest. Any takers?

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A QDRO generally cannot require a type of distribution that is not already allowed by the plan document. So unless the plan specifically states that distributions can include NON-liquidable assets (i.e, a loan), then a loan cannot be included. Therefore, I would strongly disagree that a portion of the loan, or "loan results", could be assigned to the Alternate Payee, regardless of the fact that a loan is an asset of the Trust.

Secondly, I don't think a domestic relations court would have an easy time forcing a participant to payoff a loan. A promissory note is a legal contract between the particpant and the Sponsor/Trust. Unless the court finds it to be invalid, which is unlikely, then the provisions of that agreement hold.

I couldn't find any specific language to this effect, regarding 401(k) plans. But I did find a Q&A regarding 403(B) arrangements. Language follows:

Q 13:9 What happens if a participant's 403(B) account is "loaned out" and there is no money to pay the alternate payee?

A:Because a QDRO cannot require a 403(B) arrangement to provide additional benefits, a QDRO cannot order a payment to an alternate payee that the 403(B) issuer would not be obligated to pay the participant.

Example 13-2. Larry, who is age 61 and retired, is a participant holding a Section 403(B)(7) custodial account. The account, currently valued at $9,000, comprises $2,000 worth of mutual fund shares and a $7,000 plan loan receivable over five years. If a court enters a domestic relations order directing an immediate payment of $4,500 (50 percent of $9,000) to Fiona, Larry's former spouse, the order is not a QDRO, because the custodian could raise only about $2,000 by selling mutual fund shares and the loan agreement provides for level repayments quarterly over five years. Instead, the court could order an immediate payment of $2,000 and a $2,500 interest in the custodial account with distributions payable only after the custodian receives loan repayments.

If a 403(B) account is "loaned out," the alternate payee may wish to get a court order directing the participant to inform the alternate payee if the participant fails to meet any scheduled loan repayment. The alternate payee should not seek an order directing the plan administrator or the custodian to inform the alternate payee that the participant has failed to meet a loan repayment, however, because such an order is not a QDRO (see Q 13:3). [ERISA § 206(d)(3); IRC § 414(p)]

Hope this helps.

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I'm sorry. I obviously didn't catch the other question: What happens when that loan is defaulted on?

I have no references for this one. I would assume that the Order then becomes a matter to be settled between the participant and the Alternate Payee. I doubt most plans would include specific language protecting the rights of an alternate payee.

If I find something, I'll post it ASAP.

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I think Q&A 13:9 and especially Example 13-2 contradict the conclusion that a portion of the loan cannot be assigned to the AP. They say that the AP can be given an interest in the account above the $2000 non-loan portion. The AP simply can't get a distribution until the asset is in a distributable form, as my answer states.

With respect to loan defaults, for tax purposes, it is a deemed distribution, so the AP can get the AP's share of the deemed distribution (no violation of distribution rules here; it is not a real distribution and it happens the same way to the participant). My reference to an offset distribution is limited to loan defaults when the amount is distributable, such as when the participant has terminated employment (this is what happens instead of the deemed distribution; a deemed distribution occurs when amounts are not actually distributable). It does not mean that the plan distributes a note to an AP.

As to the relationship of obligations between the AP and the participant, that is a matter of state law. If a domestic relations court rules that a participant is to deliver a certain economic value to an AP, through a retirement plan or otherwise, and the participant does something to frustrate that order (for example, by defaulting on the loan), the domestic relations court probably has authority to enforce its order. For example, the court could hold the participant in contempt unless the participant delivered to the AP the cash equivalent of the AP's loan interest to make up for the money lost through the loan that is not repaid and then distributed to the AP. Similarly, the court could hold the participant in comtempt if the participant disobeyed the court's order to make the loan payments. I concede that an impecunious particpant presents an impediment to those remedies.

While I have no quarrel with Q&A 13:9 or Example 13-2, it whould be nice to know where they came from.

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Well, I think it's obvious that this is an "interpretive" subject, to say the least. I would hesitate to do anything other than assign an appropriate portion of the participant's account total to the AP, to be paid when all receivables are settled. In any other event, I'd suggest the Sponsor/Trustees go bag some lawyers.

Regarding QDROphile's final point, I think we're coming to the same conclusion. This situation is handled outside the plan arena. Certainly the court has the right to enforce it's order, but not via the plan. The plan cannot obey the order unless it's determined to be Qualified. If it forces the plan to distribute by means other than those defined in the plan, then according to language in IRC Sect. 414(p)(1)(B) the Order is not a QDRO. If it's not a QDRO, then the

Anti-Assignment Rules under ERISA §§ 206(d)(1), 206(d)(2); IRC § 401(a)(13)would seem to apply. FYI: I'm not assuming I'm right on this point. Believe me, if it comes up, I'm deferring it to our counsel.

By the way, the Question and Example in my previous message came from Panel Answer Books; 403(B) Answer Book, 4th Ed. Chapter 13 - QDROs, Q 13:9 (sorry)

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