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Assignment of Plan Loan


Guest blaum8

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May a participant loan be assigned to an alternate payee pursuant to a QDRO? The participant is an active employee and the alternate payee is the soon-to-be former spouse. The plan does not require repayment of the loan upon termination of employment.

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Very deep can of worms, but possible.

One big issue is repayment. The fiduciary should not allow any change to the debt that makes it less likely that the loan will be repaid. Among other things, a wise fiduciary would require that the participant remain liable and that the repayment continues to be supported by payroll deduction if other payment arrangements don't result in timely installments. Of course, that makes the assignment much less acceptable to the participant.

Also, what fiduciary or record keeper wants to accept payment from a potentially unreliable outside source? Most loans are serviced by automatic paroll deduction to avoid the aggravation of monitoring timely payment, overdue notices and the like? Your plan evidently allows outside payment after the employee terminates and the loan remains outstanding, but the spouse is a stranger and may be more trouble than a former employee.

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As a follow-up, I realized the answer may be contained in the original note signed by the plan participant. I'm in the process of tracking it down to determine if it, as I hope, contains a prohibition of assignment of the note. If it does, end of story - the alternate payee cannot receive it. If this turns out to be the case, then in the current situation where the alternate payee is receiving 100% of the participant's account balance, the actual distribution will be net of loan balance.

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A nonassignment provision in the note would not necessarily prevent giving the AP the benefit of 100% of the participant's account. The trust (creditor) is not assigning the note to anyone. Restrictions on the account may be necessary or appropriate, such as no payment or distribution relating to the note until the note is paid or in default and subject to deemed or offset distribution. A lot depends on how the order tries to give the AP the benefit of the note and the trust's willingness or capacity to do it.

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Actually, a non-assignment provision in the note would prevent the trustee from assigning it to the alternate payee for repayment purposes. The QDRO would have to be reformed to specifiy whether the benefit due the alternate payee either included or excluded the loan balance.

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I think you misunderstand the nature of the relationship of the trustee and the nature of the note. The note says "P will pay to T the sum of $100." The note is an asset allocated to P's account. It is held by T for the benefit of P. But that is a function of the plan, not the note. If the QDRO awards P's account to AP, T can honor the order without assigning the note. T is still the payee. In an assignment, somebody other than the original payee is entitled to receive the loan payments. The anti-assignment provision is to prevent the obligor from having to deal with a stranger. T is not a stranger. As far as the note iself is concerned, nothing has happened.

The QDRO causes T to hold the note for the benefit of AP, but this does not amount to an assignment of the note. It merely causes T to do something else with the loan payments -- credit them to AP's account rather than P's account. Again, this is a function of the plan, not the note. The AP has no legal rights under the note (an assignee would). The AP has a beneficial interest in the value of the asset (the note) but that asset will transform to something else (loan payments and whatever those payments are invested in) before the AP has the right to receive a distribution related to the note. That is why the note has to sit in the AP's account until paid.

If you think the AP can get a distribution of the note and therefore the AP is the "assignee," I beg to differ. And even if that proposition is correct, I would disqualify the order because it would be asking the plan to do something that the plan is not otherwise designed to do -- distribute notes. As a fiduciary concern, I would not allow a distribution of the note because a premise of the loan is that it would be repaid. By allowing a distribution, the fiduciary loses influence over repayment and the situation suggests that repayment becomes less likely, and will certainly not be repaid within the plan as originally expected.

If you argue that the plan does allow notes to be distributed because notes can be rolled over directly and a spouse AP can roll over a distribution, then I would sort of agree with you that the AP rollover is not permissible because the plan is designed only to allow the obligor on the note to roll over the note, consistent with other policy behind participant loans and their requirements. But the anti-assigment provisions of the note are not what kills the proposed arrangement, it is the rollover/distribution rules and features of the plan.

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No misunderstandings here; maybe a less than adequate explanation of the exact facts. The QDRO attempted to shift liability for loan repayment to AP, while the note signed by the participant requires participant to remain liable. QDRO is now being amended to reflect options available under the plan.

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I now think that by "assignment" you were describing an attempt to substitute a new debtor. I am not sure about the use of the word, but I agree with you that this cannot be forced on the plan, no matter what the note says. I cannot imagine that the note would expressly allow the substitution. The plan should not agree to it, either.

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What if the DRO attempted to assign half the debt, but required that it be paid out of the remaining proceeds to be distributed to the alternate payee? Assuming the plan allowed for immediate payout of a QDRO, is there problem with that?

For example participant's balance is $100,000, of which $40,000 is a loan. The goal is to split everything down the middle. Could the QDRO say $50,000 to the alternate payee, but also require $20,000 of that $50,000 be immediately applied to the loan?

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I think the DRO would need to provide that the amount to the AP be the $50,000 net of the loan offset of $20,000. This triggers a nasty income tax consequence for the AP, but as has been discussed above, the consensus seems to be that a DRO cannot transfer the obligation for repayment of a participant loan to the AP.

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I think the DRO would need to provide that the amount to the AP be the $50,000 net of the loan offset of $20,000.

I think we saying are the same thing. The $20,000 would never actually leave the Plan, but would rather be applied towards the loan. Would that still be impermissable?

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Please explain how you can extinguish part of a loan within the plan.

You can make partial prepayments on a loan if the loan terms allow, but those payments come from outside the plan. A participant cannot wake up one day and decide to pay part of the loan from other funds in the account.

A loan can be fully extinguished by offset distribution, but I have explained my discomfort with this in the context of a distribution to the alternate payee. Loans are supposed to be paid and the fiduciary should not do anything extraordinary to facilitate nonpayment.

There are ways to split the loan economically, but I am loathe to do anything that changes the nature of the loan, especially if it means nonpayment or payment in a way that is not anticipated by the loan and plan terms. A domestic relations order that tries should be disqualified.

The domestic relations order could provide for a distribution of $50,000 to the AP and order the AP to pay $20,000 on behalf of the participant to prepay part of the loan, if the loan allows partial prepayment. The AP would have to devote more than $20,000 of the distribution to the effort in order to pay $20,000 after taxes, or come up with $20,000 elswhere. The plan would not enforce the $20,000 payment. Enforcement would have to be through state court.

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Please explain how you can extinguish part of a loan within the plan.

Not sure that it can, thus my question.

A participant cannot wake up one day and decide to pay part of the loan from other funds in the account.

A participant generally can't do that, because there has to be a distributable event. In the intial post I indicated immediate payouts for QDRO, thus the alternate payee does have a distributable event.

I know that the QDRO could specify $50,000 to the alternate payee. A separate order could require the alternate payee to give $20,000 to the participant to pay on the loan. I was just curious as to whether the same result could be achieved by just requiring the $20,000 be applied without the money actually leaving the plan. I generally won't ask a question if I already know the answer.

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When I don't know otherwise, I fall back on the general principle that you can't do with a QDRO something that you can't do absent a QDRO except for those special things that are expressly allowed for QDRO transactions, such as distributions to the AP before the participant is eligible and avoidance of early distribution taxes. We don't have much authority on how to handle loans, so I am very conservative about doing extraordinary things with them under a QDRO.

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  • 2 weeks later...
Guest Kevin A. Wiggins

There are four questions that can be derived from the first question.

1. Can a plan permit the assignment of an obligation to re-pay the loan to the alternate payee?

2. Can a QDRO force the plan to accept the assignment of an obligation to re-pay the loan to the alternate payee?

3. Can a plan permit the assignment of the proceeds of the loan re-payment to the alternate payee?

4. Can a QDRO force the plan to accept the assignment of the proceeds of the loan re-payment to the alternate payee?

Here are my answers, for what they are worth.

1. Yes. Subject to ERISA's fiduciary and PT standards, a plan can pretty much loan money to anyone. Nothing would prohibit the fiduciary from waiving any non-assignment clause in the note. This is particularly important in a community property state where the debt will often be community debt. (Query: in a CP state, if the participant defaults on a plan loan that is CP debt, can the fiduciary go after the non-participant spouse's assets for loan repayment? If so, can it pay the proceeds to the participant's account?)

2. I'm not sure it can, but I honestly don't know. It may depend on the facts. In this case the QDRO is trying to force the plan to enter into a particular investment. I don't think a QDRO can do that. The fiduciary could say he or she does not think the loan is a prudent investment and would violate ERISA. A QDRO can't force a plan to enter into an investment that would violate ERISA.

3. Yes.

4. I think so. A lot of plans say a QDRO can't do this, but I think they are wrong. I think ERISA and the DOL guidance should be interpreted to allow a QDRO to do this.

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