Loan partial payments

[Guest Pavlick]

I am trying to determine if it is universal in the recordkeeping industry to NOT ACCEPT partial loan payments. In otherwords, when we set up a new participant loan, we establish a fixed amoritization schedule. The only option the borrower/participant has is to make the scheduled payments or payoff the entire outstanding loan. Our Omniplan system cannot accommodate an 'extra payment to principal' like you might do with your mortgage or credit card. I've also confirmed that Fidelity does the same thing. Is there something different offered by other service providers out there?

[pmacduff]

We use Relius and it does allow us to enter adjusted loan payments if we need to. We can enter any mix of principal and interest or enter just principal or just interest. I think partial or incorrect loan repays are a "pain" in any software! You're correct though, participants assume sometimes that plan loans are set up to be like the bank mortgage or car loan where you can pay varying amounts. I try to get all plan participants to stick to the amortization unless they are paying off the loan balance in full.

[pjkoehler]

Pavlick: You dont' have much discretion with regard to accepting payments that are less than the scheduled amount for a couple of reasons:

(1) Code Sec. 72(p) treats a loan as a taxable distribution unless it meets certain requirements including "level amortization" over the term of the loan. Code Sec. 72(p)(2)©. To satisfy this requirement, the loan documents must regard such a failure as an event of default. Failure to make a payment when due violates this code section and results in a deemed distribution. Reg. Sec. 1.72(p)-1, Q&A-10.

(2) The loan documents are part of the governing instruments of the plan with respect to which a plan administrator or trustee has a fiduciary duty to act in accordance with their terms. Such terms will include methods by which a borrower may cure a default, for example, payment is made within a specified grace period dermined under the regs and the effect of the borrower's failure to cure, which can be automatic acceleration of the principal balance.

[Guest Pavlick]

pjkoehler: Thanks for the feedback, but maybe I wasn't clear with the phrase 'partial payment'. I didn't mean that the participant was paying LESS than their payment due, I meant they wanted to pay MORE. As I said, we don't (and as far as I can tell neither does any other service provider) allow an 'extra payment' against principal. The participant's intent is to pay off their loan quicker than scheduled, and thus save interest. That requires some sophistication of loan accounting. The question is is there any recordkeeping system that is capable of handling that?

[pjkoehler]

Pavlick: Ok, the issue is prepayments. I think the plan's obligation to accept prepayments whether partial or full is a matter of the loan documentation, specifically the terms of the promissory note and the plan's loan policy. The plan has no obligation to include prepayment provisions in its loan program, but if a note and policy contains such terms, ERISA's fiduciary duty under the "documents rule" would obligate the plan administrator to accept them. If this is a problem going forward, then you should modify the form of promissory note and the loan policy to prohibit partial prepayments. If you're processing loan repayment by payroll deduction this should be no problem. You would simply refuse tender of any supplemental payment. As a suggestion you may wish to allow prepayment of 100% of the outstanding principal balance to allow the participant to avoid the potential investment loss to participants.

To get back to the difficulty at hand, i.e. plan loans underwhich you conclude you must accept partial prepayments, the recordkeeping or loan servicing issue is driven by the manner in which the loan documents determine the impact of the prepayment on the outstanding principal balance. I gather from your confusion that your loan documents are probably silent or at least ambiguous on this score. In that case, what you need is an official interpretation of the language of the note and loan policy determining the financial effect that makes the most sense. For example, partial prepayments will be accumulated with interest at the loan rate and applied to reduce the outstanding principal balance but will have no affect on the amount the remaining schedule payments until the cumulative prepayments plus interest equals the cumulative remaining scheduled payments, at which point the loan terminates.

[actuarysmith]

One way to address this problem in the future is to write your loan policy so that payments can be made through payroll deduction only.

This also prevents you from having to deal with outstanding loans from terminated participants. With them, the loan payments can get even more erratic. Then YOU have to do more work and charge more - and the clients don't typically want to pay because they just fired the poor sap who sent in the loan payment 2 months late.