Trying to keep participant from defaulting on loans..

[Guest Sara H]

Does anybody have any suggestions on how to handle an employee who has 2 loans outstanding from a 401(k) plan and has found himself in over his head and cannot afford to make the loan payments? The loan repayments are currently set up as payroll deduct and he is asking for the employer to stop loan payments and he'll accept the loan default. He does have a commission coming to him in January 2010 which he said he'd put $4,000 - $5,000 on the loans, but this won't help him right now. He's currently paying $384.24 every two weeks on his loans! Neither of these loans are at a really high interest rate - one is at 6% and the other is at 9.25%, so even reducing the interest rate by refinancing wouldn't help a lot. I'm looking for ideas to keep him from defaulting on the loans (which really can't happen since the loan payments are payroll deducted). Thanks!

[PensionPro]

The participant should not be able to elect to default on the loan by stopping payroll deductions. Does the loan agreement provide for this?

[Bird]

There are differing opinions on this - assuming the loan policy says "payments are made by payroll deduction," does that mean "payments are made by payroll deduction and you can't change them, ever" or "any payments that are made shall be made by payroll deduction as a convenience to the plan sponsor/administrator, and if you elect to stop them, so be it"?

I think the first interpretation runs afoul of some payroll law or other, especially if the policy is a separate document from the plan, as it usually is, so I don't think there would be ERISA preemption of state laws, therefore I think the second interpretation is correct.

And if he stopped now, the loan wouldn't default until the end of next quarter, assuming the statutory max date is used, so he could conceivably make up the payments with the bonus income as suggested, although my experience with those promises is that won't happen. Oh, I guess you'd better make sure the first missed payment occurs in October, not September, so the projected default date is March 31, not Dec 31, since the bonus is coming in January.

(It's going to be a PITA for someone, but not me, so I'm happy to suggest it.)

[BG5150]

Could the employer "lend" the employee his commisison check (or a part thereof) early? Say, give him $2,000 up front. Then he can pre-pay a bunch of loan payments and be ahead of the game.

[masteff]

So supposing he gets the $4000-5000 in January and pays all the past due pmts and pays the remainder on the loan w/ the smallest balance... what balance and payments does that leave him with? Would it eliminate the smallest loan?

The "pro" of using the commission to pay on the loans is it reduces the balances and therefore the amount of taxable income he'd have if he eventually defaults.

The "con" of using the commission to pay on the loans is it might not eliminate either or both loans, which could still leave him in a cash flow crunch.

Another thought... if you conclude it's okay for him to request (preferrably in writing) to stop his loan payments, would you also conclude that he could choose to only stop one of the loan payments and continue paying on the other?

[Guest Sara H]

Thank you for all of your posts / suggestions / comments. The loan policy (which is separate from the plan doc) states that "The loan must provide at least quarterly payments under a level amortization schedule. If the Participant is currently employed by the Employer, the Plan Administrator will require the Participant receiving a loan from the Plan to enter into a payroll deduction agreement to repay the loan." In addition, the language regarding default is as follows "DEFAULT. The Plan Administrator will treat a loan in default if: • Any scheduled payment remains unpaid beyond the last day of the calendar quarter following the calendar quarter in which the Participant missed the scheduled payment; or • The Participant makes or furnishes any false representation or statement to the Plan. The Participant will have the opportunity to repay the loan, resume current status of the loan by paying any missed payment plus interest.

If he put the $4-5 thousand on the loan, it wouldn't pay off either of them, but my hope was that we could re-amortize the remainder of the loan to be paid off by the original due date to reduce his payment.

Thank you for some of the points - (i.e. stopping payments on only one of the loans and making sure if he misses a payment that it happens in October so that the loan actually doesn't default until March 31st).

I will put this information together and present it to the employee/employer.

Thanks again!