Intentionally Defaulting on a Loan

[austin3515]

Participant takes out a new loan, and payments are via payroll deduction.

For whatever reason the participant now believes they cannot afford to repay the loan. In fact they send a letter to the Administrator saying "cease all loan repayment deductions from my paycheck."

Where I come from, if the participant says stop withholding something, you must stop withholding (with a few exceptions).

What do you do? Stop withholding? If so, aren't we creating a back door for early distributions?

If not, how can you deny a participant's request to cease withholding? What if they sincerely can't afford it? Medical bills, etc.?

[FundeK]

This is exactly why there shouldn't be loans from a RETIREMENT plan....

Any chance that you have an in-service option in this plan? Could you possibly offset the loan via in-service distribution?

[austin3515]

I'm not sure that that changes the answer? The problem that I have is that the people have signed a loan and cannot afford to repay it.

I guess the overriding question is what is the trustee's obligation to collect the outstanding balance? Surely it's different than a bank trying to collect a mortgage, no? Is it really that different from when someone terminates employment?

[mbozek]

Austin- isnt the risk of allowing defacto in service distributions the reason why employers take the position that employees cannot stop loan repayments because state labor/ wage withholding laws are preempted by ERISA. The employer has an obligation to the other participants to prevent disqualfication of the plan. The employer and plan administrator are not the employees debt consultant. If the employee cannot afford all of the payments that he or she is obligated for then declare bankruptcy and let the bankruptcy judge sort it out. Would the answer be any different if the employee asked to stop health insurance premium withholding under a 125 plan because he has other bills to pay ( bought a new car)?

[QDROphile]

The paln administrator will have some tough decisions about how to handle the default. Will the plan try to collect by other means? If the plan does not intned to enforce loan obligations, are the loans prohibited transactions? It IS like a bank deciding what to do about an unsecured debt in many respects.

[Harwood]

Some of the discussion here is relevant to the question:

http://benefitslink.com/boards/index.php?act=ST&f=20&t=25199

[austin3515]

Awsome!

What happens then if the employee's pay is no longer sufficient to cover the loan repayments?

Reduce the net pay check to zero? Or a deemed distribution?

Talk amongst yourselves...

[R. Butler]

Here is another thread where the issue is discussed. There are several if you do a quick search

http://benefitslink.com/boards/index.php?s...opic=10321&st=0

[mbozek]

Q; isnt the practical problem of collecting on defaulted loans who will pay for the cost of collection: the plan or the participant. I dont think the plan admin can decide not to collect on the defaulted loan because of the difficulty or cost of collection since this would invite other participants to take out loans and default. This is why the best policy is to enforce repayment of loans by salary withholding as agreed to under the loan agreement until the ee declares bankruptcy.

[austin3515]

RButler, that post was awesome... Thanks!