Loan Defualt due to Employer Error

[Guest lavander30]

A 401k Participant is continuing to see loan repayment deducted from bi-weekly paycheck. The Employer changed payroll systems mid-loan and although the new system continued to withhold loan payments on schedule, the system did not report the loan information on the remittance data sent to the recordkeeper; therefore loan payments were not ACH'd from Employer account for this participant.

The TPA and employer eventually discovered where the error occured. The employer sent in a lump sum check to cover the missed payments (unfortunately after the official cure period). The participant was still sent a 1099-R for deemed distribution.

If the participant was completely under the impression that he was meeting his loan obligation and the mistake of fact actually occured due to an HR system problem, is the loan really in default? Shouldn't the TPA be able to use this information to issue a corrected 1099? At this point, the TPA refuses to issue because they do not recognize that a mistake of fact occured and stress that the payments were not applied...the loan is defaulted no matter what the reason.

One other point to mention: when the ER lump sum was remitted last year, the TPA led the ER to believe that (because of the particular circumstances) they would take the lump sum and apply to amort. as if the payments had arrived on their due dates - this obviously did not happen.

Your expert opinion is greatly appreciated!

[R. Butler]

My only thought is that this is not actually default. The payments were made; the employer just didn't remit. In some respects it is analogous to a failure to timely deposit employee deferrals. If the employer doesn't properly remit the deferrals you don't adjust the W-2's. Can't the recordkeeper just correct the 1099?

[mbozek]

Q- Why is the TPA refusing to change the 1099? Is the TPA the payor? My understanding of reg 31.3402(0)-2(g) is that the party actually making the payment is the payor for 1099 purposes and not the agent for the payor. You need to review the agreement with the TPA to determine who has the final say on correcting a 1099-R. As far as the 72(p) regs are concerned there is no specific reference to when a payment is deemed made. Q/A-10 of the regs state that the failure to make an installment payment when due in accordance with the terms of the loan results in a violation of IRC 72(p)(2)©. If the terms of the loan require that repayment be made by payroll deduction then the loan has never been in default if the amounts were withheld. It can be argued that under applicable law the employer is the agent of the plan for the collection of loan instalments and therefore payment under 72(p) was made in a timely manner by the ee even though the plan did not recieve the funds. Frankly I dont know why the TPA is making such a big deal out of this minor issue. U need to find counsel to discuss this mater with the TPA.

[Erik Read]

And I would think the employer would want counsel as well, considering they "held" payments due to the plan in the employer account after withholding from the participant - perhaps a loan from plan to the employer? I know a few DOL auditors who'd love to get there hands on a situation like that before it goes in for compliance.

Just my thoughts... may be other circumstances we're missing that show otherwise, but I could see this being a big headache down the road.

[Guest lavander30]

Thanks so much for all of your qualified responses!!!

The TPAs stance is that a default is a default, no matter what the reason. And, in working with them in the past, for some reason correcting 1099s scares them to death!

My argument is that the participant has no responsibility to make sure that his loan payments are actually being applied to the trust; he agreed to repay the loan via payroll deduct. and contractually, he did fulfill his obligation.

I have worked in this business for a few years now and the TPA has been doing this much longer than I as well as having a pretty solid reputation - - so, I did question my own opinion.

You insight and reg. references will help tremendously!

[mbozek]

I am having a difficult time understanding why the TPA is acting this way and where they get the authority to call this shot. Whether a loan is in default is determined by the Plan administrator under the terms of the plan ... not the TPA. As indicated previously the loan is only in default if the payments are not made in accordance with the terms of the loan. If the payments were withheld from the participant's paycheck by salary deduction then the loan was never in default Maybe u need to get another TPA.

[Belgarath]

I agree with mbozek. We would never handle something like this in such a manner, unless specifically instructed to (in writing) by the plan sponsor. Most plan documents grant the Trustee/Plan Administrator the power to interpret the document provisions, and administer the plan accordingly.

At the very least, if I were the participant, I'd hire an attorney to see about a suit, and I'd complain to the DOL. As a plan sponsor, I'd think it was a pretty poor risk to follow the TPA's interpretation.