Loan overpayments - What do you do ?

[Guest hyper]

What do you do when loan repayments are withheld and submitted to the trust for a participant loan that has been previously satisfied ?

We have a situation in which the Trustee/recordkeeper is cutting a check (possibly several checks) directly from the Trust to the participant for the amount of the loan overpayment. No reporting is done on this distribution from the Trust. The client would prefer to continue this practice.

I am concerned that once the $ is in the trust it is considered plan assets and can not be distributed for any reason, other than the standard 401(k) reasons (termination, 59.5,etc.) The issue could be corrected in payroll before $ is sent to the Trust but that means more payroll manipulation and possibly more errors.

How do your cleints correct this problem ? I have seen the overpayments applied to the account as "loan interest" but I think this is also an issue because the participant pays more interest than was disclosed in the truth in lending disclosure.

Can this $ be distributed from the trust ?

[Demosthenes]

Yes, it can and should be returned. It's a mistake of fact.

If it's happening over and over, client might want to think about fixing their payroll system/vendor.

[mbozek]

The loan agreement signed by the plan and the particpant is a legal contract stipulating the amount to be paid by the employee under the truth in lending law which the plan is subject to under ERISA. Ovrpayments should be returned to the employer for refund to the em[ployee as a mistake of fact because the plan was never entitled to the funds. The excess contributions cannot be considered employee contributions to the plan if the employee never agreed to make such contributions.

[Guest hyper]

Demosthenes and mbozek:

I am not sure this error rises to the level of a "mistake of fact" under the code and ERISA. The IRS has interpreted a mistake of fact very narrowly in the past. See PLR 9144041. Procedures are in place to stop the loan repayments but sometimes it just does not happen, for whatever reason. This does not seem to be a mistake of fact, it is just an operational error.

The error does need to be corrected but I am not sure it can be done by making a distribution from the Trust; netting the loan overpayment against a future wire to the trust and adjusting the participants payroll may be the way to do it, as opposed to making a distribution from the Trust.

[mbozek]

Why is this any different than a retirement plan that mistakenly deposits a check that is not payable to the plan and the check is accepted by the bank/trustee? Surely the deposit is not a plan asset just because it is credited to the plan's account. Since the plan has no right to the funds it can only refund the payment to the payee.

[Guest hyper]

Good point, but I think the big difference is the loan overpayment is more likely to be veiwed an an operational error and not a mistake of fact since the issue can be corrected without making a distribution from the Plan.

[Demosthenes]

A rose by any other name ...

Call it what you will, the $ either belong in the plan or they don't. If the Trust doesn't send out a check, how will you correct? Adjust a future paycheck to reduce deferrals and use the over payment of the loan $ in substitution? This in a payroll system that already has problems with X dollars for Y pay periods. Wonder what the W-2 will look like?

Not being argumentative but a judicious application of Occam's Razor might be called for.

[Guest hyper]

I agree payroll adjustments being made in a troubled payroll system are not ideal but I am not sure a distribution is the way to correct the problem either. See Correcting Plan Defects Q & A 141 and 141 on this site.

These Q&A's say it would be highly unlikly that the IRS would allow a plan to distribute contributions made on behalf of an ineligible participant due to a mistake of fact. These contribuitons clearly don't belong in the trust but could not be distributed due to a mistake of fact (according to the Q&A, at least). The Q&A goes on to say a distribution could possbilty be made under self correction but I am not sure that self correction would allow a distribution to be made that is otherwise prohibited under the code.

[R. Butler]

Lets be practical here, probably have 2 options:

1. Put the excess payments in a holding account within the plan. Reduce future employer contribs. by the excess amount. Make the employee whole outside of the plan.

2. Treat it as a mistake of fact; return the excess to the employer. Again make the employee whole outside of the plan.

I prefer option #1, but does it really matter? Are the IRS & the DOL really going to come down hard on the plan sponsor if that sponsor in good faith chose either of these methods & kept appropriate documentation showing exactly what was done & why?

[mbozek]

IRS rulings do not cover correction of mistakes outside the parameters of the qualification requirements which result in the plan receiving property that it has no legal right to possess under state laws governing trusts. Funds which are transferred to the plan in error are not plan assets and must be refunded to the owner because the plan has no legal right to the funds under legal doctrines of unjust enrichment or conversion. If the trustee mistakenly transferred funds into the plan's account that were legally the property of another customer the plan could not rely on the Exclusive benefit rule to prevent the trustee from withdrawing the funds and restoring them to the rightful owner.

[Guest hyper]

Mbozek:

Nobody is being unjustly enriched and I am not trying to argue that the trust can keep any $ mistakenly transferred due to the exclusive benefit rule. There are definatley errors that the IRS would consider a "mistakes of fact" under the code, I am just not sure this is one of them.

Thanks for all the comments.

[Guest Noodle]

Just for discussion's sake, what about considering them AFter Tax contributions, retroactively amending the document to allow for them (if it didn't) and to allow for their in-service distribution at any time? No adjustment to W-2 needed.

- Noodle

[Brian Gallagher]

My 2 cents:

The way we do it was suggested above:

Take money from participant's account (plus/minus investemtn results) and put the money in a suspense account. The plan will short its next check (or wire) by the amount "suspensed". The company makes the participant whole outside of the plan. Since taxes were already taken out, there is no adjustment to the W-2.

I don't see how this is a mistake of fact. It's just a mistake. From PLR 9144041:

"Mistake of fact is fairly limited. In general, a misplaced decimal point, an incorrectly written check, or an error in doing a calculation are examples of situations that could be construed as constituting a mistake of fact. What an employer presumed or assumed is not a mistake of fact."

Plus, how long ago did this happen? You only have one year to correct a mistake of fact.

[401 Chaos]

FWIW, I have heard at least one IRS Audit cap person informally agree with Mbozek that amounts clearly placed in the trust in error (and not a mistake in fact) should not be considered plan assets and therefore the rules regarding distributions or reversions of plan assets should not apply. Of coure, this IRS official could not point me to any specific guidance or clear guidelines for documenting and reporting such reversals. Like R. Butler, I agree that the key here is for the plan sponsor to carefully document the correction. If the IRS or DOL have real problems with how plans are handling these situations, they should provide more detailed guidance.

[FundeK]

Sorry to bring up the issue again.....

Do you think you could use a deminimus in this situation? What if the payment submited is $.50 over the loan repayment, could you apply this to interest?

This sometimes happens when the plan sponsor creates their own amort schedule and comes up with their own payment amount. Of course when the loan is issued from the recordkeeper, it may be off slightly.

[R. Butler]

Sorry to bring up the issue again.....

Do you think you could use a deminimus in this situation? What if the payment submited is $.50 over the loan repayment, could you apply this to interest?

This sometimes happens when the plan sponsor creates their own amort schedule and comes up with their own payment amount. Of course when the loan is issued from the recordkeeper, it may be off slightly.

For us it depends.

1. If its a daily val'd plan with an outside recorkeeper; the recordkeeper returns the excess before it is put into the account.

2. If its balance forward or for some other reason I amhandling; I do it the way you suggest for small amounts. Is that correct? Probably not, but practically if it is really deminimus, who cares. I highly doubt that either the IRS or the DOL would even notice $.50 or $1.00 & if they did I just don't think they will care.