loans and plan documents

[Guest MTransue]

I have a new takeover client for the 2002 plan year. The entity is a C Corp, and the plan was initially effective in 1981. It was just a profit sharing plan, and permitted loans.

In 1997, the plan was restated the same provisions as the original plan document .

However, in 1999 the plan document was rewritten, adding a 401(k) provision to the plan. During this rewrite, loans were not permitted. The SPD distributed to the participants stated loans were not permitted for the 1999 and 2002 rewrites.

Sometime during later 1999, early 2000, 2 of the owners (33% each), took a loan and then a second one several months later. The second loans taken had interest rates as 0%. I'm still trying to track down a signed promissory note for all 4 of these loans.

Their document was restated already for 2002, again not permitting loans. I know that I can amend their current plan document to permit loans, but what can we do retrospectively regarding:

1. Operational failure of the document. (favoring HCEs)

2. Not having a reasonable rate of interest.

3. Anything else I may not be considering...

Thanks for any insight.

[E as in ERISA]

Considering those loans as prohibited transactions (because they don't meet the ERISA exception for loans), having them repaid immediately, paying the excise tax...

[Guest MTransue]

It's a C Corp, not an S Corp.

[E as in ERISA]

A loan to a party in interest is a prohibited transaction if it does not meet ALL of these requirements in the exception in ERISA 408:

(a) available to ALL participants on an equal basis;

(B) not made to HCEs in an amount greater than made available to other employees;

© made in accordance with specific provisions in plan;

(d) bear a reasonable rate of interest; and

(e) adequately secured.

Don't both loans violate the first three rules, and don't the second loans violate the first four rules?

[actuarysmith]

Operational Failure or Form Defect???

Would you say that the plan has a form defect because it doesen't allow loans even though they were clearly taken, or an operational defect - loans were taken even though they were not allowed.

If it is the latter, you could probably self-correct. If it is the former, you may have to go VCR/CAP.

I would probably have the owners re-pay ASAP with a reasonable rate of interest imputed. Then create a formal loan policy in the plan doc, and then have the owners take loans back out (with legitimate paperwork).

Any thoughts to the contrary?