Loans to Actively Employed Participants Only

[smm]

Can participant loans be limited to participants who are actively employed by the employer at the time the loan is requested? Client does not want to make loans to terminated employees, alternate payees andor beneficiaries. Loan is payable in full at terminatin of employment and payments must be made by payroll withholding.

Thanks

[FundeK]

Can participant loans be limited to participants who are actively employed by the employer at the time the loan is requested? 

Yes. If the loan policy states that payments must be made via payroll deduction, it eliminates terminees, beneficiaries, and anyone who is not receving a paycheck.

[Kirk Maldonado]

FundeK:

Do you see any problem with that limitation under the DOL regs regarding loans?

[smm]

That was my concern.

[FundeK]

Are you referring to the "available on a reasonalbly equivalent basis" provision? I am including a section from the ERISA outline book below. Sal always states is better than I ever could! The basic loan documents that I have administered in the past never allowed a terminated employee to receive a loan. I never really thought about why until I wrote a set of loan FAQs and found this section in Sal's book.

2004 ERISA Outline Book Chapter 14: Prohibited Transactions - Section II (Definitions): Part B.2. (Lending of plan assets - participant loan exemption)

2.a.2) Limiting loans available to former employees and beneficiaries. The reasonably equivalent rule generally requires that loans also be available to former employees and beneficiaries, as well as to active employees. However, in Advisory Opinion 89-30A, the DOL stated its position that the availability of the loans may be restricted to parties-in-interest. That would include all active employees (see the parties-in-interest category under ERISA §3(14)(H)), and only former employees or beneficiaries who satisfy the party-in-interest definition in ERISA §3(14). Former employees or beneficiaries generally are not parties-in interest, relationships with a business substantially owned by the employer. Merely being a participant (i.e., still having an unpaid vested accrued benefit in the plan) does not make a former employee a party-in-interest.

[Kirk Maldonado]

FundedK:

That is funny, I read the same language and get exactly the opposite conclusion that you reach.

His language says that if a former participant is a party in interest, you have to give them a loan. I see absolutely nothing in his language that supports your position that you can deny loans to all former employees, including former emlpoyees who are parties in interest. In fact, his language says the exact opposite; that you must make loans available to them.

[KJohnson]

Kirk, I agree with you. But I thnk that the instances where someone who terminates emloyment and remains a party in interest would be few and far between Once you terminate you will, by defintion, no longer be an employee of the plan sponsor. I would assume that terminated employees remaining as officers would also be rare. Typically anyone terminated would also be removed as a fiduciary for the Plan. I guess where you would have to look out is 10% shareholders, directors in rare instances and relatives of various parties in interest. Thus, while rare you would have to keep your "eyes open."

On the other hand, can't your provide that repayment/offset is required/accelerated upon termination of employment, death, retirement, disability or otherwise entitled to a distribution? Wouldn't this get around the problem? I guess they could take a loan but it would immediately be accelerated and offset--the same as taking a distribution. I guess an alternate payee who is not entitled to an immediate distribution could still be a problem. However, couldn't you just amend your plan to provide for immediate distributions to alternate payees and still avoid the issue?

[Harwood]

Between requiring payroll deductions to repay loans and having termination of employment making the loan due and payable, aren't all terminees and alternate payees locked out of applying for a loan?

[FundeK]

Kirk said:

I see absolutely nothing in his language that supports your position that you can deny loans to all former employees

KJohnson said:

But I thnk that the instances where someone who terminates emloyment and remains a party in interest would be few and far between

Thank you for bringing this to my attention. I was incorrect in my intpretation.

[Kirk Maldonado]

KJohnson:

I've not researched the issue, but my guess is that if the alternate payee's benefit would exceed $5,000, you can't force an immediate distribution.

As a practical matter, I've only seen two QDROs in DC plans where there wasn't an immediate distibution, so I think that the odds of an alternate payee asking for a loan is pretty slim.

[KJohnson]

I think the idea is that you are executing on the security interest upon acceleration. Consent to the "future" acceleration/offset is given at the time of the loan is taken which I think is suffcient. The following is from the 401(a)-20 regs.

(2) Participant consent is deemed obtained at the time the

participant agrees to use his accrued benefit as security for a loan for

purposes of satisfying the requirements for participant consent under

sections 401(a)(11), 411(a)(11) and 417.

You would therefore be back to where you might be "eligible" for a loan, but it would make no sense to take one. To get a loan you would have to agree to offset/acceleration at the time you are eligible for a distribution. If you try and take a loan when you are eligible for a distribution, you would have an immediate offset.

[mbozek]

Most employers limit plan loans to participants who agree to salary reduction for repayment to avoid administrative hassels inherent in having the ee pay the employer/PA and then manually transfering the funds to the plan. For large plans with multiple worksites, plans and payrolls it is administratively impossible to handle loan repayments made to the employer or plan ad other than by Sal reduction. I am not aware of any requirement that prohibits an employer from limiting loan repayment to participants eligible for salary deduction as a reasonable condition for the loan. I agree with KJohnson's statement that a participant may be eligible for a loan but not be able to take it out because of some other provision in the plan.

[bzorc]

In a large plan that I administered in a former life, terminated participants were allowed to continue their loan repayments. Their loans were "converted" to a monthly amortization schedule, and they were required to send in a check every month. If they didn't, they got a friendly reminder letter, and if they missed a second time, their loan was considered in default and was "distributed" to them. Doesn't that sound like fun?