Overstated Loan

[Guest TPA Guy]

I have a question about a situation we are in. A participant was in dire straights. They needed money BADLY. She already had a loan outstanding and did not qualify for a hardship or in-service. When all else failed we refinanced the loan so she could get at least some money. Ex. She had a loan outstanding of 1000.00. We did a new loan for 2000.00 and a loan payoff of 1000.00 for a net check of 1000.00. When we requested the check we inadvertently sent the request over for 2000.00 instead of the 1000.00. When the check left the trust it made the Plans cash negative (1000.00). We tried to stop the check in time put participant had already spent the money. We redid the loan in our system to match what actually happened but now it is blatantly obvious that she received more than 50% of her balance for a loan. When this Plan gets audited this will be a problem.

Is there anything we can do to make this fly? Can we have the Trust issue a 1099 for the extra 1000.00 we paid out to her or since she did not qualify for a hardship this can’t be done? No one can give me a straight answer to this problem, so I am turning it over to the experts. Thank you so much in advance…

[Guest Kevin1]

She can use 50% of her account balance as security (for the first $1,000) and come up with additional outside security (wedding ring, husband's shotguns, bass boat, etc) for the other $1,000. This can be done for up to a $10,000 limit. Loan policy may have to be changed.

[Guest TPA Guy]

She can use 50% of her account balance as security (for the first $1,000) and come up with additional outside security (wedding ring, husband's shotguns, bass boat, etc) for the other $1,000. This can be done for up to a $10,000 limit. Loan policy may have to be changed.

I guess I don't understand. Are you saying she has to come up with money to put back into her account (don’t think she can do that, unless it came out of payroll or from a rollover) or are you saying she just needs to show some sort of collateral???

[austin3515]

She just needs to come up with the collateral. OF course if she defaults, the collateral now becomes a plan asset, and it may be an asset that the plan is not allowed to invest in, and yada yada yada... It is a clever solution, but it might not be practical...

[Archimage]

Even thought this may be a viable solution, your plan document and/or loan policy may not allow this. I would treat the amount over the 50% threshold as a deemed distribution. I base this on the following:

§1.72(p)-1. Loans treated as distributions

Q-4: If a loan from a qualified employer plan to a participant or beneficiary fails to satisfy the requirements of Q&A-3 of this section, when does a deemed distribution occur?

A-4: (a) Deemed distribution. For purposes of section 72, a deemed distribution occurs at the first time that the requirements of Q&A-3 of this section are not satisfied, in form or in operation. This may occur at the time the loan is made or at a later date. If the terms of the loan do not require repayments that satisfy the repayment term requirement of section 72(p)(2)(B) or the level amortization requirement of section 72(p)(2)©, or the loan is not evidenced by an enforceable agreement satisfying the requirements of paragraph (b) of Q&A-3 of this section, the entire amount of the loan is a deemed distribution under section 72(p) at the time the loan is made. If the loan satisfies the requirements of Q&A-3 of this section except that the amount loaned exceeds the limitations of section 72(p)(2)(A), the amount of the loan in excess of the applicable limitation is a deemed distribution under section 72(p) at the time the loan is made. If the loan initially satisfies the requirements of section 72(p)(2)(A), (B) and © and the enforceable agreement requirement of paragraph (b) of Q&A-3 of this section, but payments are not made in accordance with the terms applicable to the loan, a deemed distribution occurs as a result of the failure to make such payments. See Q&A-10 of this section regarding when such a deemed distribution occurs and the amount thereof and Q&A-11 of this section regarding the tax treatment of a deemed distribution.

(b) Examples. The following examples illustrate the rules in paragraph (a) of this Q&A-4 and are based upon the assumptions described in the introductory text of this section:

Example 1. (i) A participant has a nonforfeitable account balance of $200,000 and receives $70,000 as a loan repayable in level quarterly installments over five years.

(ii) Under section 72(p), the participant has a deemed distribution of $20,000 (the excess of $70,000 over $50,000) at the time of the loan, because the loan exceeds the $50,000 limit in section 72(p)(2)(A)(i). The remaining $50,000 is not a deemed distribution.

Example 2. (i) A participant with a nonforfeitable account balance of $30,000 borrows $20,000 as a loan repayable in level monthly installments over five years.

In addition, you probably have a prohibited transaction under section 4975.