Loan Default

[nancy]

Can an active participant default on a loan if they no longer authorize payroll withholding for the loan payments? Does this present any other problems other than a deemed distribution? This is a NHCE.

[LCARUSI]

Yes the participant can default by rescinding a payroll deduction agreement and yes it should then be treated as a deemed distribution.

I think it creates some minor recordkeeping headaches. FOr example, you will have to consider the loan (technically still outstanding)in any future calculation for the participant of the maximum loan available - if he/she wants another loan.

[Guest Laura]

If you allow one participant to do this, you are establishing precedent. This may open the floodgate.

Also, the preamble to the DOL require that the loan be "bona fide" in order to qualify for the prohibited transaction exemption for participant loans. Allowing participants to discontinue repayment at will for any reason jeopardizes the loan's status as a bona fide loan. Arguably, it is not a bona fide loan because it lacks the requisite intention to repay.

On the other hand, many states have rules which prohibit garnishing of wages. So, if you deny the participant's request to discontinue payroll deductions towards repaying his or her loan, and your company is subject to jurisdiction in a state with these type of labor statutes, then you risk the participant asserting a claim under that state's wage law.

So, you can't really win this one. Sorry.

[Guest kseward]

We had this come up in the last year. We did finally amend our plan to allow voluntary defaults during employment if the employee had adequate money in his/her rollover account.

The one problem we had with this type of voluntary default was that it allowed an employee to get at money, that under the normal in-service distribution rules they could not withdraw. Money such as company match and profit sharing. That is why we only allow voluntary default during employment with money in their rollover account.

[Guest jkirschbaum]

Laura's analysis is correct. There must be a bona fide loan at the outset. However, it is unlikely that the state law will permit an employer to continue to take a forced payroll deduction if an employee wants to rescind it.

Our practice is to act real tough up front but roll over if anyone insists on rescinding the deduction. We still send a nasty note demanding repayment but that gets ignored. Permitting a voluntary default in the plan or procedures would seem to be asking for trouble.

[QDROphile]

To prevent voluntary default by rescission of payroll withholding, the plan should consider taking an assignment of pay as security for the loan. Watch state law limits on assignment of pay.

[Guest MelG]

If a participant files a Petition of Bankruptcy or Receivership, would the outstanding loan in all cases go into default? It appears that if the employer continues to process loan payments through payroll deduction, after all bankruptcy payments are made, the loan should not go into default?

[Guest jkirschbaum]

MelG, you are correct, the mere filing of the petition does not change anything. However, bankruptcy lawyers are not known for their tax expertise. They will list the plan on the petition as a creditor and the plan administrator will get the mandatory stay. That will have to be honored and the employer will have to turn off the payroll deductions - thats when we get the default.

[Guest Fay]

Is this perhaps a way around the loan before hardship withdrawal rule? In other words, if the employer requires a loan first, can the employee refuse to sign permission for payroll deduction? Then the loan should be denied....Does this open the way for hardship withdrawal to occur?

[LCARUSI]

Fay -

It seems to me that if the employee refuses to sign up for payroll deduction, he or she is refusing to accept the terms of the Plan's loan program and is refusing to request a loan. I don't think that opens the door for a hardship.