Can a loan be issued to fix a distribution error?

[TBob]

Doctor A had a practice that employed two valuable employees. They had a 401(k). The doctor decided to terminate the practice and the 401(k) Plan. Employees were given distribution options. The doctor then joined as a partner in another practice and the two employees were hired by the new partnership. Money was rolled from the old plan to the new partnership's plan.

In doing the final accounting of the old plan, the prior TPA made an error. Basically, one of the valuable employees got a sizeable chunk of the Doc's rollover account. She subsequently fell on hard times and took a distribution of the rollover balance in her new account and spent the money. The error was discovered by prior TPA after the money was distributed by the current TPA.

The participant can't pay back the excess amount to the plan and there is a dispute (of course) as to who should pony up to make the Doc's account whole (seems pretty clear to me!). Doc and prior TPA are trying to come to an equitable solution so the participant can pay the $ back. Prior TPA suggested that the plan issue a promissory note from the Doc's account to the participant. The Doc's account could hold the note as the participant pays back the money with interest.

I know that the Prior TPA should pay the amount that the Doc's account is short and go after the participant outside of the plan (or perhaps have the participant make installments to them rather than the plan). I know what the appropriate correction should be but, would the loan from the Doc's account be a prohibited transaction assuming the Doc would even agree to this? I have tried reading about PT's and the exemptions for participant loans but all the information I read talks about loans from the participant's own account rather than from someone elses account. Help?

[TBob]

Since no one seems to want to weigh in on this one...I'll try to answer it myself and see if anyone shoots me down.

The question is...can a loan be issued from participant A's account to Participant B and have B pay the loan back. Seems obvious but I need cites to back up the argument.

1.401(a)-13(d)(2) says..." 2) Benefits assigned or alienated as security for loans. (i) Notwithstanding paragraph (b)(1) of this section, a plan may provide for

loans from the plan to a participant or a beneficiary to be secured (by

whatever means) by the participant's accrued nonforfeitable benefit

provided that the following conditions are met..."

Seems to me that since the loan would be secured not by the participant accrued benefit but by the accrued benefit of another participant in the plan, it would violate the anti-assignment rules.

Here's an excerpt from the loan policy of the plan..."SECURITY FOR LOAN. A participant must secure each loan with an irrevocable pledge and assignment of 50% of the nonforfeitable amount of the borrowing participants accrued benefit under the Plan.

While this should be enough to convince the prior TPA that the best course of action is to put the funds into the plan (with earnings) and work out some arrangement outside of the plan, are there any other suggestions?

[JanetM]

Seems to me the prior TPA made a huge mistake and should be responsible for making the Doc whole. The plan can (if allowed by plan document, if this didn't cross over the end of the year, and if not past end of cure period) reclassify the distribution to a loan and have participant pay back.

[TBob]

Having the participant reclassify the distribution as a loan would be fine if the participants account balance supported the loan but since she took almost all of her money (and some of the Doctors) when the distribution was made, the loan would end up being more than 50% of her balance.

[JanetM]

What if you classified the part of the participants account as loan and the rest as hardship?

You have serious problem with prior TPA.

[TBob]

Janet - you are right about the prior TPA!

The prior TPA error in this case caused the Doc's account to be understated and the Ppt's account to be overstated. Her account was distributed and now the Doc's account is short.

The problem that I have with classifying any part of the Doc's account as a loan or hardship is that the Doc is not paying back the money nor received any of the benefit of the money. The participant received the over payment and needs to pay back the money (which she can't do in a lump sum at this time but might be willing to make payments on it).

Prior TPA's suggestion to hold a loan note in the doc's account, which the participant pays off does not work for me. Seems to me that this would constitute a loan from the Doc's account to the participant. My read of the prohibited transaction rules tells me that you can't secure a participant loan with someone else's accrued benefit. This also seems like a violation of the antiassignment rules as well.

Prior TPA needs to make the plan whole and make arrangements with the participant outside of the plan.

[JanetM]

Tbob,

reread edited post - should have said part not doc.

Can't hold note in doc's account. Prior TPA needs to cough up funds to fix doctor, then pursue the participant outside of the plan.

That is why they have insurance - to cover errors and omissions.

[TBob]

I hope they have errors and omissions coverage! Thanks!