Excess Loan in a DB Plan - How to Handle

[emmetttrudy]

We recently took over the administration on a one person DB and DC Plan from another administrator. Almost immediately we realized the DB Plan was broken. In late 2010 the participant took a $50,000 loan from the 401k Plan. No problem with that. But then in May 2011 the administrator allowed him to amend his DB Plan to allow for loans, and he subsequently took out another $50,000 loan, this time from his DB Plan. We are discussing going through the VCP to correct this. The options seem to be repay the loan or deem a taxable distribution. Let's assume he would like to take the $50,000 as a taxable distribution. Two questions come to mind: One, the 1099-R would have been due earlier this year if it is to be considered a 2011 distribution. So is that just filed late? Secondly, he has made loan repayments per the amortization schedule, so the current outstanding balance of the loan is about $36,000. At this point, does he take the full $50,000 as the distribution, and then consider the $900 loan repayments he has been making as contributions to the Plan?

[SoCalActuary]

This is well documented in several places, including Sal Tripodi's materials.

Short version: The loan was immediately taxable, with premature distribution penalties.

The repayments of principal balance created non-taxable basis against future benefit payments.

The repayment of interest was generally not deductible, so the participant was putting after tax money into the account to be taxed again.

The plan benefit is still intact, and the plan loan is still an asset for funding. This changes only when the trustee declares the loan in default.

The total accrued benefit will be offset upon distribution to the extent that the full benefit was not paid.

Any outstanding loan balance at distribution is applied against the total benefit.