Loan to plan terminee?

[Guest Rachelw]

Hello,

This is my first time posting to this board, so I hope I am posting this question in the correct area.

I have a plan that wants to allow a terminated participant to take a loan. I have never had this issue come up before. To me, it just makes sense to not allow this. There is no control over the repayments, b/c they would not be coming through payroll deductions. I would think the loan policy would have to be amended as well as the promissory note?

Any advice/experiences anyone could share with me would be appreciated.

Rachel

[Mike Preston]

Your instincts are good. Take them further. Not only would the loan policy and promissory note need modifying (assuming they both reference mandatory payroll withholding for loan payments), but it is possible that the plan document and SPD (via an SMM) would need modification, too. Monitoring the loan will usually be additional effort, because the lack of payroll withholding means it is much more likely that the borrower will default.

One final thing: if the modification is being made in order to assist a former HCE, the plan could have non-discrimination issues, too.

None of the above, other than the last comment regarding non-discrimination, precludes the plan sponsor from going down this path. At least you will have warned them!

[JanetM]

Since this person is terminated they should be eligible for distribution. To avoid taxes they should roll to new employers plan and take the loan that way.

[Mike Preston]

Since this person is terminated they should be eligible for distribution. To avoid taxes they should roll to new employers plan and take the loan that way.

Maybe I'm just not understanding things, but just because somebody is terminated doesn't mean that they are eligible for a distribution. They might have JUST terminated and the plan has a one-year break-in-service rule, along with a "pay after the end of the year during which said break-in-service takes place" rule. That would mean that distribution might be as far off as sometime in 2009.

Also, you are implying that by taking the loan from this plan, rather than from a new employer (which may not exist, and, in fact, its non-existence may be the catalyst for the loan in the first place) that the individual in question will definitively incur tax sooner than if they borrowed from a new employer's plan? I don't think that is necessarily so, either.

Can you explain the circumstances you are implying?

[Guest fender5150]

Is anyone aware of a maximum interest rate for plan loans? It might be advisable to maximize the interest rate as an investment option.

IE: If you're going to buy a car, why not borrow the money from yourself, and pay yourself a high rate? this translates to a high yield in your 401kplan.

I've wondered about low interest loan on a 401k for some time. Why kill your earnings with a low interest loan (aside from the desire to live beyond your means)?

[Mike Preston]

A true thread-hijack. Care to put your comment into a new thread?

[Guest Rachelw]

FYI - My participant is not eligible for immediate distribution, b/c he has a pending QDRO that needs to be withdrawn from his account.

[rcline46]

That QDRO and or its transmittal may also have put a 'freeze' on the account making the loan impossible to take. Also review the plan document and loan program, as they may preclude a former employee from taking a loan.

[JanetM]

Mike, it has been a long time since I saw a plan that has a 1 year BIS clause. My experience has been as soon as they are shown as termed they are eligible for distribution. The OP has added the QDRO issue as reason for no distribution.

[Mike Preston]

My plans frequently provide for employer contributions in the year of termination along with a vesting schedule. There are usually compelling reasons for both when dealing with a plan that is set up as a new comparability plan. When those two circumstances exist, an employer pays out immediately after termination of employment only if they wish to pay out again should there be a requirement for a contribution in the year of termination.