Loan default

[rlb64]

Participant took out a 5 year loan back in March of last year. The employer forgot to set up withholding. Since it's the employer's fault, the employer is instructing us to not deem the loan. They are just going to start up loan repayments now.

The question I have is if we follow the client's instructions, is this just a taxation issue for the participant, or is there a plan disqualification issue as well?

Thanks

[QDROphile]

Plan terms often follow the rules of section 72 and a bad loan is a prohibited transaction. You could end up with disqualification because of failure to administer the plan in accordance with its terms.

[jquazza]

Plus, you can't blame it all on the employer, the employee should have noticed the loan payments were not deducted from his/her paycheck.

[FundeK]

The question I have is if we follow the client's instructions, is this just a taxation issue for the participant, or is there a plan disqualification issue as well?

Both. If the Client feels so strongly that it was their error, they can help the participant out by assisting him/her with the taxes and penalities outside of the plan. Unfortunately the regs don't allow a correction for "administrative error". Also, I have seen DOL letters that addressed this type of issue. They said that it was a breach of fiduciary duty and made the plan deem the loans. I don't have the exact wording at hand, but it you would like it, I could probably quote the cites they used.

[Leopurrd]

I agree with JQuazza. The employEE is fully responsible for the loan repayments, not the employER.

However, I'm curious as to how the employer will handle the situation.....will they do as suggested with the taxes/penalties/etc??

[rlb64]

Well, the employer agrees that the employee has some blame as well. They suggested they would probably cover any taxes if the IRS comes in and says the loan was administered wrong and should have been deemed. The concern I have as TPA is whether this is the worst that could happen.