Bankruptcy judge orders participant to stop loan payments?

[Kathy]

:confused:

We have a copy of an court order for a participant to stop making his 401(k) loan repayments as a part of his Chapter 13 bankruptcy.

However, we are concerned that stopping loan repayments through payroll deduction will put the Trustee in a bad position. The loan program, note and pledge say that the participant will repay the loan through payroll deduction. As long as the participant is drawing a paycheck, isn't it the obligation of the administrator and trustee to make sure that loan is repaid as required? Can this ruling supersede those obligations?

And, if the employer/trustee/administrator allows him to stop his loan payments, do we default the loan an ddeem a distribution? continue to accrue interest on the outstanding balance on the books? ever begin payments and collection again? when the participant does finally quit and receive a distribution of the rest of his account, what do we do with the accrued interest since the default/deemed distribution as I don't think we include it in the taxable distribution reported to the participant?

Thanks for your help!

[jpod]

Absent something flakey in the order, the payroll deductions must stop; ask for a quick review of the order by your/the plan's legal counsel. Assuming payroll deductions stop as a result of the court order, follow the normal default/deemed distribution rules.

The bankruptcy court, thankfully, is more interested in economic reality and protecting the participant's true creditors than the rules for qualified plan loans.

[mbozek]

Federal Bankruptcy law is not preempted by ERISA and Bankruptcy judges have broad powers to enforce the bankruptcy laws. Since the order was directed to the participant and not the plan there is a issue as to the termination of withholding. However, the plan should have recieved a copy of the bankruptcy petition filed by the employee which would instruct the creditor ( plan) to cease collecting payment. The purpose behind filing for bankruptcy and declaring plan loans as debts is to allow the plan administrator to cease payroll witholding without violating IRS rules that the loans must be treated as an enforceable debt. If the participant stops loan payments then the loan goes into default with the attendant tax consequences to the participant. IN Ch 13 cases the ct is concerned that the participant will favor repayment of loan to his own account over payment of the loans to other cerditors since the bankruptcy law requres equitable treatment for all creditors.

[RCK]

I agree with the previous comments--once you have been notified of the bankruptcy you have to stop withholding the loan payments. If your participant is upset about this, send him back to the court. We have had a couple of cases where the court allowed 401(k) loan payments to continue.

RCK

[Kathy]

Thank you all for your help.

Our concern is to protect the trustee who was completely unaware of the bankruptcy until he received a copy of a page of what appears to be the order to stop contributions an dloan payments to the 401(k).

The participant wants the loan payments stopped. However, we feel the trustee has an obligation to collect the payments owed the trust if at all possible, unless he has something more official from the court telling him not to. We did immediately direct him to seek counsel from his attorney so hopefully they can get the correct documentation.

Thanks again.

[jpod]

RCK:

In those cases you've seen where the court has expressly allowed a participant to repay his plan loan through payroll deduction, did that reduce the amount he had to pay to his creditors as part of the Ch. 13 plan?

If so, talk about a "miscarriage of justice." A participant would be taking money from his left-hand pocket and putting it in his right-hand pocket, all to the detriment of creditors.

[RCK]

jpod:

I have no idea what the details of each situation were--all I know is that there were either two or three. I'd sure like think that the decision that did not adversely affect the true creditors, and that the judge realized that a 401(k) loan is just a premature withdrawal followed by increased post-tax employee contributions.

However, I'm having kind of a cynical day, so I'm just not sure.

RCK