Terminating Plan - Outstanding loans

[Guest nmyers]

We have a plan that was apart of a controlled group. The company has since gone out of business, and the board of the controlled group now wants to terminate the plan. All of the employees in the plan were terminated as of 12/31/2007. Although, everyone has a distributable right to their money, no one has taken their funds do to market perfomance. The existing employer wants to stop administering this plan and get rid of the cost of filing 5500's, the issue is a participant has an outstanding loan. The loan policy does not have any language to accelerate the loan to default status incase of plan termination. The only way the participant could default the loan was if they missed 3 consecutive payments. The loans are not payroll deducted, they are paid ACH, which allows terminated participants to continue paying on their loans. Although, its not stated in the document to call in these loans for any other reason than missed payments, is there anything in the law that could get us around this issue?

[J Simmons]

Incident to the termination, you could simply distribute that part of the EE's benefits that are represented by the unpaid balance of the note (i.e., the creditor end of the note currently being the Plan) by transferring the promissory note from the plan to him. It would be an in-kind distribution. He'll be taxable on the balance of unpaid principal and interest at that time, and you would so report it on the Form 1099-R issued to him for the year.

The note could not be rolled by him into an IRA. So you might ask him if he wants to pay the entire note off prior to his benefits distribution, so that he could then roll over that part of his benefits too.

[Guest nmyers]

Incident to the termination, you could simply distribute that part of the EE's benefits that are represented by the unpaid balance of the note (i.e., the creditor end of the note currently being the Plan) by transferring the promissory note from the plan to him. It would be an in-kind distribution. He'll be taxable on the balance of unpaid principal and interest at that time, and you would so report it on the Form 1099-R issued to him for the year.

The note could not be rolled by him into an IRA. So you might ask him if he wants to pay the entire note off prior to his benefits distribution, so that he could then roll over that part of his benefits too.

We've mentioned carrying the loan outside of the plan to get off the books. Our client isn't willing to do so, and neither are we considering the participant only has $700 left in the plan, and carries $8900 loan. She's not a good risk. She took a distribution back in April for the remainder of her account. I believe what's left is probably just loan repayments. In not so many words the participant has told us that she would not default on the loan in 2009, since she took such a large distribution earlier in the year. She said she would be willing to possibly default the loan in 2010. Something tells me she's done this before.

The other plans the Employer sponsors are 403(b) plans. She can't transfer her 401(k) to the 403(b) plan, but could she rollover her balance along with the loan to the 403(b) plan. I grabbing at straws at this point.

[J Simmons]

The decision to distribute incident to plan termination the note in-kind to her should be (per the plan document) up to the employer, not the borrowing participant.

She might find that 2009 tax rates would be lower than those in 2010. So the ER doing the in-kind distribution in 2009 rather than waiting until 2010 for her to default might actually be to her advantage--and the ER gets out of having to do admin for any of 2010.

[Guest nmyers]

The decision to distribute incident to plan termination the note in-kind to her should be (per the plan document) up to the employer, not the borrowing participant.

She might find that 2009 tax rates would be lower than those in 2010. So the ER doing the in-kind distribution in 2009 rather than waiting until 2010 for her to default might actually be to her advantage--and the ER gets out of having to do admin for any of 2010.

Okay, maybe I'm missing the concept of transferring the loan in-kind. How exactly does that work? She couldn't transfer it to an IRA. Where is it being transferred?

[J Simmons]

To her, as part of a taxable distribution. Since she is then both the obligated debtor and the note holder, the loan is essentially canceled out. She makes no more payments on the loan.

[Bird]

I'm not sure you need anything special in the loan policy to provide for default upon plan termination, but as noted, you can just "distribute" the note in-kind which is effectively defaulting on it. Or you can amend the policy as part of the termination and provide for the default. Whatever - but the participant has no say in this matter.

[Guest Sieve]

If the plan allows in-kind distributions, then this individual could request that the loan be rolled over to another tax-qualified employer plan if the trustee of the other plan would be willing to take an assignment of the loan from the trustee of the current plan.

[Jean]

When a plan terminates, participants lose the rights they had under an active plan. I'm not convinced that the loan policy must state default occurs upon plan termination. A loan repayment is a contribution to the plan. Contributions to the plan should have ceased on the date the board declared the plan termianted. This would result in a forced default of nonpayment.

[J Simmons]

Just a comment on terminology. I'm not sure I would call a participant loan that is distributed or 'canceled' incident to plan termination to be a default of that loan. For this reason, I agree with Jean that it need not be stated in the loan policy that the loan "defaults" on termination of the plan. The note is an asset of the plan that it has authority to distribute incident to the termination of the plan. (Several loan policies I have seen 'accelerate' the due date of the balance of interest and principal, but that's not quite the same as a default.)

I also wouldn't consider loan repayments to be "contributions". If the loan was to a third party, the plan would continue to receive repayments of the loan from the date the plan is terminated until it distributed that 3rd party loan to an employee as part of the distribution of benefits to him or her (and then the 3rd party would make loan repayments directly to that employee).

On the other hand, as Jean states, the plan may not accept contributions once the plan is terminated, at least not actual contributions.