Deemed Loan in 401(k) Plan

[lisabroc]

We have taken over a 401(k) plan which had a deemed loan for missed payments. From what we could see, the plan had the normal cure period listed in the plan documents. Loan amortization schedule was based on bi-weekly payments but employer payroll frequency was semi-monthly and neither the recordkeeper nor employer caught this discrepancy. Employer submitted payments semi-monthly. The recordkeeper had instituted an Auto Default/Deem loan process if loan payments were not up-to-date and deemed the loan without notification to the participant or plan sponsor. The end of the cure period is 9/30/15 according to the RK but loan was deemed 7/1/15 and the participant was not given an opportunity to bring it up to date.

Should the RK have amended the plan document/loan policy for the Auto Default/Deem procedure? No updated SMM's or SPD's have been provided. The only documentation is a letter to the plan sponsor. RK says it following IRS regulations; however, it doesn't look like it following the terms of the plan as far as i can tell. I'm not sure if the loan agreement disclosed the terms of the auto default process. They claim they cannot correct or reverse the 1099 which is hard to believe.

[BG5150]

First thought is that the 1099 hasn't even been issued yet!

[lisabroc]

Yes that is why we would like the current recordkeeper to correct it before it is issued. However, they are not taking any responsibility and we will likely have to issue a corrected 1099 on our end somehow.

[QDROphile]

There is a difference between a record keeper not having any responsibility and a record keeper doing what it is told to do if given specific instructions about what to do by the plan administrator. When the plan administrator figures out what to do under the circumstances, then it should direct the reord keeper what to do (if the action is within the reocord keeper's functions). By refusing to follow the instructions of the plan administrator with respect to a matter within the plan administrator's authority, the record keeper is making itself a fiduciary and then it will have responsibility and potential liability.

[Bird]

The end of the cure period is 9/30/15 according to the RK but loan was deemed 7/1/15 and the participant was not given an opportunity to bring it up to date.

I agree with the comments above, and I would insist on them reconciling the issue quoted above. It sounds like their "system" is in charge and they can't be bothered to fix it, and are trying to bully everyone else into submission by saying they are following IRS regs.

[lisabroc]

Thank you for your comments on this topic! Very good points. This is very helpful and we hope to get a successful outcome with this additional "ammunition."

[BG5150]

And a word for the plan administrator: if the RK cannot maintain records and process transactions that are not only following IRS/DOL regs, but also following plan provisions, then a change in RK is in order.

[QDROphile]

BG5150:

I have never had a client follow that good advice.

[BG5150]

Have the RK document what the criteria are to "auto-default" a loan. Then have them document when and where in the amortization schedule the loan payments satisfied those criteria.

Did the RK come up with the loan agreement? Or did the plan adminstrator or TPA do it?

Compare the answers from the frist two questions to the language in the loan agreement. Do they match up?

If not, put your concerns in writing and ask the RK to respond to them point by point.

Keep plan adminsitrator and plan sponsor and even the investment professional involved each step of the way.

[lisabroc]

I am trying to schedule a call with the RK manager and will raise these questions. The good news is that the plan sponsor has changed recordkeepers so we won't have this problem moving forward. We discovered the loan issue during the conversion. That is the reason for the reluctance on the part of the prior RK to deal with this. They maintain that their "system" won't allow them to correct at this point since this assets are no longer there. In my experience with other RK, manual corrections can still be made even if the assets transfer to another RK.

Thanks for the help!

[BG5150]

They can almost certainly supress the 1099-R, especially since it has not been issued yet.

[SavingsRUS]

Note that there is another fiduciary issue here as well: The Plan Sponsor is obligated to enforce the terms of the loan, even where it has been deemed distributed for taxation purposes. In other words, technically the Plan Sponsor is required to pursue repayment of a deemed distributed loan, and it seems like the lack of notice from the RK and the lack of communication with the participant regarding both the need to bring the loan current and then the need to continue repayment after deemed distribution is something that could be viewed by some auditors as a fiduciary breach.

[lisabroc]

It sounds like that the best course of action is to bring the payments up to date based on the original bi-weekly loan schedule and apply the "missed payments" to the transferred loan. We will deal with the 1099 issue separately. Further, I would think we should re-amortize the loan under the employer's semi-monthly payroll frequency with the new recordkeeper if possible.

[BG5150]

Does the plan allow for refinancing of loans? If so, I would redo the loan with the correct paramaters. Otherwise the pariticpant is bound to the original loan paperwork.

[austin3515]

I don't think changing the am schedule from bi-weekly to semi-monthly would be a refinancing. For example, we've had situations where payroll switches from bi-weekly to semi-monthly and we just reamortize to the "equivalent" payment. the ee's were notified of their new payment amount.

[BG5150]

OK. I agree with the fact that it's not a refinance. Makes sense.

However, I do think the person would have to complete new loan paperwork. I don't think a mere amortization schedule is a legally enforceable document.

[lisabroc]

Thanks for the comments. I would agree that it is not a refinance to conform to the employer payroll frequency. In addition, I have requested a copy of the loan paperwork in the meantime to review the terms of the loan.