Hardship as Loan Offset

[austin3515]

Got a participant with a loan who cannot afford the payments anymore (got very sick, but is still working). She has a lot of medical expenses not covered by insurance AND she has a son who needs tuition money for school in the fall, so she really wants to get rid of her loan payments.

Question: Can she request a hardship distribution for the above situations in the form of a loan offset? It seems strange given that the proceeds will be used to repay a loan, and not to fund the intended expenses, but I have always read that hardships can be in the form of loan offsets.

Note that the participant could take a hardship in cash (because she is indeed eligible for the distribution) and then use the proceeds to separately repay the loan. I am aware of no requirement that a hardship distribution actually be used for its intended purpose. Once the hardship exists, the participant is eligible for the distribution. They could blow the money at the casino for all the Plan Sponsor knows.

PS, the plan is in a 90 day black out right now so my idea in the previous paragraph would not work.

[ERISAnut]

Austin,

Your wording is very confusing but I think I get the essence of your question. You are correct that a hardship is 'deemed' to exist under the safe harbor conditions (regardless of whether the need is an immediate and heavy financial burden). Therefore, under such condition, the participant may take a hardship from the plan. Since the check is issued directly to the participant, there couldn't possibly be any control over what she actually does with the funds.

Your question, however, seems to imply that she has a plan loan and simply wish to discontinue the payments of the loan. The method chosen to do this is to take a hardship from the plan instead of defaulting the loan. I have always maintained the position that the participant can simply send a written request to the payroll department to discontinue having the loan payments deducted from her payroll. Of course, the payroll department may argue that they have a legal right to continue withholding the loan payments; but the garnishment rules of the particular state may not support the payroll department (after all, the loan payment being withheld from payroll is not per a court order). As soon as this payment is discontinued, it would constitute a default on the loan; where the participant may cure by paying of the loan in full.

[QDROphile]

And if the particpant does not pay the loan in full after default, what actions must the fiduciary take to collect?

[austin3515]

There was a big thread on that exact topic a month or so ago - it was split down the middle re: whether or not that was acceptable. I personally wish the DOL/IRS would issue some guidance on that issue.

I figured this "hardship" might be the path of least resistance.

[ERISAnut]

The loan procedures are already in place to govern the pattern of events surrounding a loan default. Contrary to popular belief, a loan default is simply when the borrowed fails to abide by all conditions in the loan contract. Failure to pay is simply one way, but a loan may go in default when the participant actually quits his job. Now that the loan is defaulted, the procedure is that the participant has a right to cure the default by paying the loan off in full (as typically the contract would state that the loan is considered due in full upon default).

The issue here would imply that the loan contract would state that the loans are to be paid by payroll deduction. This in no way supercedes a payroll departments responsibility to honor the instructions of the employee who is due the funds. If such employee instructs the payroll department to discontinue any deductions, that is the authority; nothwithstanding any other agreements the employee may have. This becomes an issue of state law, not federal. The loan provisions are already written to address the federal end since the loan is considered 'adequately secured'. The loan policy may actually be written to not require payments be made through payroll deduction. In the event it is written, that doesn't supercede the garmishment rules of any state.

[masteff]

1) Austin - See the 1.72(p)-1 regs, Q&A-13... it speaks somewhat to your original question.

2) Adding to Erisanuts comment... or if the part doesn't cure then it's a deemed distribution and results in a taxable event, which would be nearly the same effect as the in-service withdrawal. The main difference would be Q&A-19(b)'s restrictions on subsequent loans.

And as indirect proof of IRS intent of ability of EE to cancel loan payments, Q&A-19(b)(2)(i) says "For this purpose, an arrangement will not fail to be enforceable merely because a party has the right to revoke the arrangement prospectively."

3) QDROphile - as you've posted that connundrum before, I've given it prior thought. This is the first time I've really poured thru the regs to try to answer it.... I would point to reg 1.72(p)-1 Q&A-19.

In paragraph (a) it says: "General rule. Except as provided in paragraph (b) of this Q&A-19, a deemed distribution of a loan is treated as a distribution for purposes of section 72. Therefore, a loan that is deemed to be distributed under section 72(p) ceases to be an outstanding loan for purposes of section 72."

So, for everything except it's effect on subsequent loans, the loan ceases to be outstanding. And paragraph (b) even permits a subsequent loan w/out mandating that the deemed loan be repaid first .

Now to be my own devil's advocate... this merely reflects the Service's position and does not address potential ERISA fiduciary responsibility. I guess I'd be curious to know if anyone can find any examples of the DOL taking action against a plan sponsor for failure to collect a participant loan.

[ERISAnut]

The fiduciary responsibility is to ensure the loan is adequately secured at the time it is issued, and to continue to ensure the plan participants, as a whole, are protected from a loan that is not being repaid. Now, when viewing these rules, you have to account for all that has changed since these rules were first written. First, many plans now have daily valuation where the loans are adequately secured at the time of issuance by selling off the participants mutual funds and issuing a loan. Therefore, this transaction does not affect any participant in the plan other than the participant receiving the loan. While he receives cash from the plan, his accrued benefit remains unchanged since the plan assets in his account include a receivable of the loan amount. So, he doesn't pay. The other particpiants inside the plan are not adversely affect in any way by this.

Now, the circumstances would be different in the event the plan is on a balance forward platform and the loan is a pooled asset. In such event, the plan administrator has the fiduciary responsibility to protect all plan participants from losses resulting from the non-payment. To guard against this, may traditional plans would not allow any subsequent distributions (i.e. inservice at 59 1/2) until the outstanding loan was paid off (either prior to application or by using the proceeds from the distribution).

So, what is our fact pattern?