Can loans be taken from rollover accounts prior to employee becoming a

[John A]

Many plan documents provide for accepting rollover money prior to an employee becoming a participant. Can the plan document or loan policy provide for loans from this rollover money prior to the employee becoming a participant?

[Guest [Pat M]]

John, I believe loan provisions come under the rules of those plan programs that must be made available only for the exclusive benefit of participants and beneficiaries.

[John A]

Thanks, [Pat M]. I agree. So the question becomes: Is the employee I describe a "beneficiary" of the plan due to having an account in the plan? I realize the employee described is not the typical "beneficiary" (who receives death benefit if participant dies), but where is "beneficiary" defined for plan loan purposes?

[pjkoehler]

I think you can safely analyze the employee as a "participant" because he clearly is eligible to receive a benefit under the plan, which is squarely within the definition of a "participant" under ERISA Sec. 3(7). The employee is, of course, 100% vested in his rollover account, even though he may not be eligible to make deferral elections or receive allocations of employer contributions, because he has not yet satsified the applicable eligibility requirements. Whether or not such participants are eligible for participant loans is a plan/loan policy design question. The statutory prohibited transactions exemption for participant loans applies to loans to parties in interest, including "participants" so long as the exemption requirements are satisfied, among which is the requirement that the loan be made pursuant to specific provisions set forth in the plan. ERISA Sec. 408(B)(1). Typically, a loan policy does not permit loans to be made to terminated employees with a deferred vested benefit, even though they are also "participants" for ERISA and Code purposes, though clearly ineligible for make or receive future contributions. Allowing employees to transfer their rollover accounts into the plan prior to satisfying the eligibility requirements for future contributions, creates another class of "participant," which a prudently drafted loan policy should also address.

[This message has been edited by PJK (edited 05-24-2000).]

[bzorc]

I have had many clients who allow loans from rollover accounts before they become participants. The loan policy should address this, as mentioned above.

[Guest JB2]

I would view this differently. A participant is defined by the plan. This is someone who has satisified the eligiblity requirements and is employed as of the next entry date.

Loans, are usually restricted to participants -- which would be again be determined by the plan definition.

I do not think that a plan that allows rollover contributions to be made by a non-participant will change the participant definition. Therefore, they should not be able to take a loan.

[pjkoehler]

JB2, if a plan's eligibility criteria for the right to make salary deferrals or receive allocations of employer contributions was co-extensive with "participant" status, then termination of employment would automatically terminate that status, because being an active employee is an inherent part of such criteria. But we know that terminated employees with deferred vested benefits still enjoy some benefits, rights and features of the plan. For example, in an ERISA Sec. 404© plan, they have the right to direct the investment of his or her account, choose from among optional forms of benefit and determine their benefit commencement date, even though they ceased to be eligible to make salary deferrals or receive employer contributions. When a plan permits employees to make rollover contributions prior to the date they are employer contribution-eligible, it potentially creates a third class of "participant." Those that satisfy the eligibility criteria for salary deferrals and employer contributions, may enjoy more extensive benefits, rights and features, but you can't say in the abstract that only those employees are "participants." Whether or not a rollover-only eligible "participant" has a right to receive a plan loan, is a question of plan design. While, for many good reasons, many plans will require a participant to be employer contribution-eligible, nothing in ERISA or the IRC would prevent the plan from granting rollover-eligible participants the right to obtain a loan secured by an interest in their rollover accounts.

[This message has been edited by PJK (edited 05-25-2000).]

[Guest [Pat M]]

I re-read 3(14) - guess the law is clear that loans, if allowed, must be made available on a reasonable equivalent basis to parties-in-interest. Employees are parties-in-interest. If a plan loan provision is unclear as to who is allowed a loan, then is the assumption that all classes are included? Also, a Plan must have a reasonable expectation that the Plan loan will be re-paid, before permitting the loan. If a Plan has a one-year wait on contributions, then the Plan has some philosophy or basis for excluding new hires. Maybe there is high turnover (high expectation that loans would not be repaid). Maybe the Plan wants employees to "earn" the right to participate. Shouldn't the same reason apply to loans?

[Guest JB2]

The point I was trying to make is that the plan (and the loan policy) is the source to determine who may take a loan.

Eligibility criteria most certainly determines how someone becomes a participant. Once you have met that criteria, then you are suject to all the rights and features of the plan. I agree that that covers terminated employees. I do not think that simply because a plan allows a non-participant to roll funds from a prior plan that this changes the loan eligibility rules. They are two separate features.

[pjkoehler]

JB2, the point I was trying to make was that the plan could establish eligibility criteria to obtain a loan that are less stringent (e.g. just being an active employee) than the eligibility criteria to accrue an employer-provided benefit. ERISA Sec. 404(a)(1)(D) requires a fiduciary to act in accordance with the plan "insofar as such documents and instruments are consistent with the provisions of [Titles I and IV of ERISA]." Since ERISA Sec. 3(7) defines the term "participant" to mean "any employee . . . who is or may become eligible to receive a benefit of any type from an employee benefit plan. . . ," any fiduciary that interprets a plan to treat an employee on whose behalf the plan holds a rollover account, but who has not met the age and service requirements to accrue an employer-provided benefit, as a nonparticipant breaches his fiduciary responsibility. Surely, the plans your thinking of would never pay a benefit to a nonparticipant. Can you imagine a plan denying a benefit claim by a terminated employee with only a rollover account because he didn't satisfy the age and service requirements when he terminated, for the sole reason that he was not a participant, or would the plan have to create a special category of nonparticipant distributees? Most plans that permit relaxed rollover contribution eligibility don't specifically label those employees as "participants," but any other construction is blatantly inconsistent with ERISA and therefore, that's the only sensical interpretation you can give it.

[This message has been edited by PJK (edited 05-26-2000).]