Recordkeeper shortcoming?

[Guest caseyb]

We area large employer who utilizes Merrill Lynch as our plan's recordkeeper. We just implemented a participant loan program, and the recordkeeper is telling us they are unable to post anything but the full repayment amount or a multiple of it. They are also unable to post a negative loan repayment.

Has anyone run into this situation with a recordkeeper? Fidelity was the recordkeeper at my last employer, and they posted any partial loan repayment to principal. Not being able to post a negative loan repayment doesn't make sense to me, as someone's entire paycheck may be reversed (an overpayment of wages for example) and I feel the negative loan repayment should be posted to their account and added back to the loan balance.

I see this as a shortcoming of their RK system - can others shed some light on their experience or what is allowed by regs?

Thanks!

[Peter Gulia]

Sadly, Merrill Lynch is not alone; other recordkeepers have this weakness of seeking to record only an expected loan-repayment amount. You might re-read the plan's service agreement to consider whether the recordkeeper's work is within, or in breach of, its agreement, and to consider what remedies the plan might pursue. Of course, you'd evaluate this one weakness along with the wider context of the plan's overall satisfaction with recordkeeping services.

On the point about a "negative", some recordkeepers don't allow an automated record that could generate even an indirect outflow from a plan trust. Instead, a service provider (including a directed trustee) wants the plan fiduciary's written instruction that a payment into the trust was a good-faith mistake that can be unwound under ERISA 403.

Please call me if you'd like help.

[Jean]

Another valid reason for not allowing the negative loan repayment, and this would apply to traditional plan contributions also, is that due to market fluctuation, the value of the loan repayment in the plan is now worth less than when it went in. If you assume a one participant plan and the only contribution to the plan is the loan repayment (hypothetical), and the investment value dropped 20%, where is the additional funds going to come from to offset the reversal?

[hr for me]

If ML is still using the same daily recordkeeping system that they started with back in the mid 90s (and I expect that they are), this is a system wide problem. You will find other recordkeepers who use the same system have the same problem because of the way it is setup. The loan amort schedule (both principle and interest) is fixed once the loan is setup. There is no varying available, except to pay the whole loan off.

Plus in the past, 401k recordkeepers have not wanted to mess with the stated signed amortization schedule and changing that. It is much harder to recordkeep partial payments and the interest changes as they are incurrred differently than the stated amortization. Since each transaction the recordkeeping system is timestamped, it isn't setup to advance the last payment date and recalculate the interest amounts on the next payments.

My very first project out of college in the early 90s was auditing 401k loan amorts for a company that allowed multiple loans at once. It was a nightmare. And that was back in the balance forward quarterly processing days. Unfortunately when the daily recordkeeping systems were setup, they still had the balance forward/quarterly recordkeeping mindset. There was no such thing as payments made online or even over the phone.

One last point...many plan documents/processes require all loan payments flow through payroll. How do you expect your payroll to be able to handle non-standard payments? Do you expect that the employee should be able to pay ML directly? If so, how are you going to update your loan balance/shutoff in your payroll system? How are you going to know the extra payments that are made? Honestly, there are some payroll systems out there that aren't setup to handle 401k loans well either...especially a non-standard payment. And often the communication sequence is not setup for the 401k recordkeeper to pass that information back to the client. And the recordkeeper doesn't want to be responsible. And as a benefits manager, I would not want the payroll processor(s) to be able to accept instructions to change the loan payments without authorization nor would I want the plan recordkeeper to accept payments without my knowledge.

When I have seen this issue in the past, I have recommended that the employee put the extra payments into a savings account until they had enough to pay off the loan. I truly didn't want to become their banker. We communicate very clearly to employees at the beginning of a 401k loan that this is not like taking a personal loan or credit card debt. That payments happen on a specific cycle and the only choice is to keep paying the same amount on the same cycle or to pay the whole loan off.