Defaulted loan

[B21]

We have a client who terminated employment with a hospital & had an outstanding loan through his 403(b) plan. He was permitted to continue making loan payments even after termination. He missed one scheduled payment and was informed that he had until March 1st to make a payment, which was the last day of the cure period, to prevent the loan from being defaulted. He remitted a loan payment in mid Feb but the amount of the check was off by less than $1 from the scheduled payment amount. The trustee refused to accept the payment and the check was returned to the participant prior to the March 1st deadline. The trustee also refused to accept a replacement check which could have been received by the deadline and, therefore, defaulted on the loan. Does our client have any recourse against his former employer claiming that he was treated unfairly & the loan was defaulted prematurely?

[ETA Consulting LLC]

Well, the defaulted loan should become an "actual distribution" as opposed to a "deemed distribution" since the participant is terminated and eligible for a distribution under the plan. An actual distribution is eligible for rollover; so he should roll the amount over to an IRA to avoid taxation. You just want to ensure the 1099-R isn't coded with an "L" in box 7; which it shouldn't given the fact this is an "actual distribution".

Good Luck!

[Kevin C]

You won't be able to tell if the loan was handled improperly unless you have a copy of the plan's loan rules. It may be part of the plan document or it may be a separate loan procedure. Does the employer even have anything to do with the loans? Since you mention a trustee, it's likely a vendor handled the loan.

The good news in all this may be that if he is eligible for a distribution, the loan distribution or offset is an eligible rollover distribution (1.402©-2, Q&A 9). If the plan's loan rules have the loan being offset at 3/1/2012, you may still have a chance at a 60 day rollover. Are you sure it was March 1 and not March 31? The cure period typically ends at the end of a calendar quarter.

[B21]

I understand your suggestions to have the client rollover his defaulted loan balance to an IRA to avoid the taxes & penalty. However, I don't think he has the available funds which would be approximately $25k to rollover. Is it worth filing a claim with the DOL to force the employer not to default on the loan? I believe the loan policy states a cure period of 90 days after last scheduled payment.

[Kevin C]

The DOL can only get involved with a 403(b) plan if it is ERISA covered. The easiest way to tell if it is ERISA covered is to look for their 5500 filing on the DOL website. If it is ERISA covered, they are required to file a 5500.

http://www.efast.dol.gov/portal/app/dissem...?execution=e1s1

It doesn't cost anything to contact the DOL or IRS. They may or may not be helpful. We've had clients who received phone calls from the government trying to resolve participant complaints. Sometimes, complaints even lead to plan audits.

You really need to get a copy of the plan's loan rules. Have your client request a copy. If they didn't follow the rules, they may have a problem. Following the plan's loan provisions is one of the requirements for the prohibited transaction exemption that applies to participant loans.

[ESOP Guy]

I understand your suggestions to have the client rollover his defaulted loan balance to an IRA to avoid the taxes & penalty. However, I don't think he has the available funds which would be approximately $25k to rollover. Is it worth filing a claim with the DOL to force the employer not to default on the loan? I believe the loan policy states a cure period of 90 days after last scheduled payment.

A little more complex but might be worth looking into as I suspect it will be more productive then fighting with the old trustee.

Here are the steps

1) Take out a personal loan to fund IRA rollover

2) Roll IRA to new employer plan

3) Take out new loan with new employer's plan

4) Repay personal loan

I am making a number of assumptions that you need to determine if true.

1) He can take out a personal loan for a large enough amount

2) There is a new employer and he can roll the money in the IRA to their plan

3) The new employer allows loans

4) Since you can only take a loan for 50% of your balance he would have to roll the money in the "old" 403(b) plan to the new one also to get the rollover balance large enought to take a full loan.

This is a SHORT summary of a plan it will require some footwork on your part to see if it can be done. It is alot of work, but honestly I think your fight with the old employer is a waste of time on a practical level. You could even be right, but I think the fight isn't worth it.

I suspect others on this board will add comments on the soundness of this plan or lack there of. I am sort of spit balling at this point.

edit a few minor typos.