Stopping Loan Payments while still employed

[ewatson12]

I have a participant who has said he would like to stop loan payment withholding from his check because he can no longer afford them and treat it as a taxable distribution.  My first thought is he can't while he is still employed there.  The loan paperwork (which I have not been able to lay my eyes on since new plan in transition to us) should state that it is an irrevocable pledge and conditional upon payroll deduction repayment.  As the plan sponsor, I would think they could not just stop collecting the repayments since it is their job to ensure repayment to the plan.  My next idea is to explore a hardship to pay off the remainder of the loan but I am waiting on the participant to express an immediate and heavy financial burden in one of the safe harbor instances.

Thoughts on the ability of the plan sponsor to stop withholding the payments?  I would think this would be prohibited  transaction land.

[Mike Preston]

I suppose it depends on state law.  Here in California the employer is forced to follow the employee's wishes.  If that results in a default, so be it.

[Flyboyjohn]

Agree with MP it's a state law issue and same result in Virginia.

This is an issue where ERISA does not preempt state law because there's nothing in ERISA that requires plan loan repayments from wages or when any such voluntary withholdings can be revoked.

[Peter Gulia]

Some lawyers read ERISA Advisory Opinion 94-27A (July 14, 1994) to suggest some reasoning under which ERISA might preempt a State’s wage-payment law.  https://www.dol.gov/agencies/ebsa/employers-and-advisers/guidance/advisory-opinions/1994-27a

 

For preemption to apply, Federal law need not regulate the same subject or object as what the State law regulates.  Under ERISA’s express preemption, ERISA’s titles I and IV supersede a State law “insofar as [the State law] may . . . relate to any [ERISA-governed] employee benefit plan[.]”  ERISA § 514(a), 29 U.S.C. § 1144(a).

 

Further, a participant-loan procedure’s or other governing document’s provisions about repayment of a participant loan might be a part of a plan’s ERISA § 402(b) funding policy.

 

A lawyer rendering advice about whether a State’s wage-payment law is or isn’t preempted might consider ERISA § 514(b)(4):  “Subsection (a) shall not apply to any generally applicable criminal law of a State.”  (Before ERISA § 514(e), some lawyers interpreted § 514(b)(4) as undoing a preemption that otherwise might apply if the State’s law made it a crime to violate the State’s wage-payment law.)

 

Relevant law’s several (and compound) ambiguities suggest an employer needs its lawyer’s advice.  (If the plan’s administrator is a person distinct from the employer, it too might need its lawyer’s advice.)

 

Consider that a too-hasty decision in either direction risks a breach or violation.

 

[Flyboyjohn]

Honoring the participant’s request to stop payroll deduction cannot possibly be considered a violation of any provision of ERISA or the Code.

Not honoring the participant’s request may very well give rise to state law cause of action.

Seems like any easy decision.

 

[shERPA]

I've also had this come up a few times over the year.  Here in California, I agree with Mike Preston and FBJ. 

[Peter Gulia]

ERISA § 404(a)(1)(D) states:  “[A] fiduciary shall discharge his duties with respect to a plan . . . in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this title and title IV.”

 

This might apply if each State law that otherwise could restrain the employer’s deduction from the pay of a participant who asked to stop the deductions is preempted.  (I don’t suggest that a fiduciary must follow a plan’s governing document if doing so would be a violation of an unpreempted State law.)

 

I recognize that many employers make practical choices about this intersection between Federal and State laws.

 

[Pam Shoup]

Something else to consider, does the plan do loan re-financing?  For example, if an employee takes a new loan for $1, and re-finances the old loan into the new loan, that would allow him to extend the remaining loan balance (plus $1) out to the maximum loan repayment period which would probably lower his payment amount to a more affordable number.  (Don't forget to apply the loan rules as to the max available when re-financing out to a period longer than the original due date.)

[ewatson12]

No refinancing, only 1 loan permitted.

I can't seem to find anything in reference to state law as some of the early posters mentioned.  It is an Alabama based plan

[My 2 cents]

Not a lawyer, not an expert on 401(k) loans, but...

Isn't the idea that administrators of ERISA plans are not required to be conversant with the laws of numerous states, ergo ERISA preempts state laws?  What is a plan with active participants in 35 states supposed to do, administer the repayment of loan provisions 35 different ways?

The best approach would probably be put something explicit in the plan document concerning the handling of such requests (absolutely not or whatever the participant wants, with favorable determination letters having been obtained for the plan document) and follow it without regard to the laws of the state the participant lives in.  If it's a prototype, there ought to be a yes or no checkbox in the adoption agreement concerning the ability of participants to stop making required repayments.  State laws cannot require that the provisions of a federally regulated pension plan be violated, due to ERISA preemption. 

The handling of loan repayment requirements in 401(k) plans should automatically be treated as outside the scope of state wage payment laws.  Those should not be treated as deductions from wages the way salary reduction amounts to generate 401(k) employer contributions are.

 

[Mike Preston]

Much too simplistic.  I think the standard or question is whether the state law has a material impact on the administration of an ERISA plan.  By definition this means a facts and circumstances determination.  And payroll procedures are generally considered to be the subject of state labor laws.  I suppose the logic is that since the employer has to understand the payroll laws of those states it operates in in order to do payroll, there is, at most, an ancillary impact on plan administration.

[RatherBeGolfing]

56 minutes ago, My 2 cents said:

Isn't the idea that administrators of ERISA plans are not required to be conversant with the laws of numerous states, ergo ERISA preempts state laws?  What is a plan with active participants in 35 states supposed to do, administer the repayment of loan provisions 35 different ways?

Well, that isn't quite how preemption works.  Think of it more like if ERISA requires something to be done, it would most likely preempt a state law to the contrary.  But every provision in a plan document is not an ERISA requirement.  Loans have to be repaid, but ERISA does not require that the loan be repaid by payroll deduction.  Drafting a plan document requiring that the loan be repaid by payroll deduction does not preempt state labor law, it just means that it is the only option provided to the participant to repay the loan,  and that the participant will default on the loan if payroll deduction is stopped.

[Bird]

I'd be curious to know in what state you could say "I'm sorry but you have to maintain this otherwise optional deduction from your pay."  None, I believe.

RBG beat me to it - this is an administrative requirement, not an ERISA requirement, IMO.

[My 2 cents]

I have trouble seeing the deduction to repay the loan as "optional".  Agreeing to payroll deductions was a condition precedent to receiving the loan in the first place.  If the participant signed an agreement to repay the loan based on a specified repayment schedule (to be handled via payroll deductions), there should not be a state law that would interfere with the terms of that agreement  being carried out, and unless the loan agreement gives the participant the right to cease making repayments at will, the participant should be treated as bound by the agreement to repay.

If forced to allow the loan recipient to stop repaying this loan, the sponsor ought to consider amending the 401(k) plan to prohibit such a choice for all future loans.  If the participant cannot afford to repay the loan, it should be considered from the start as a withdrawal (and subject to all in-service restrictions on withdrawals).  401(k) plans are not supposed to be used to pay current  expenses (except for permissible hardship situations) - they are supposed to stay in place to provide retirement income/assets.

[RatherBeGolfing]

24 minutes ago, My 2 cents said:

If the participant signed an agreement to repay the loan based on a specified repayment schedule (to be handled via payroll deductions), there should not be a state law that would interfere with the terms of that agreement  being carried out, and unless the loan agreement gives the participant the right to cease making repayments at will, the participant should be treated as bound by the agreement to repay.

It is clearly not preempted by ERISA since ERISA does not require repayment by payroll deduction.  I struggle to justify why an agreement made between employee and employer should carry more weight than state law.  

 

24 minutes ago, My 2 cents said:

If forced to allow the loan recipient to stop repaying this loan, the sponsor ought to consider amending the 401(k) plan to prohibit such a choice for all future loans. 

To prohibit what choice?  Payroll deduction altogether?  I guess they could amend the plan to say you can't stop your payroll deductions, but since they can't actually prohibit the participant from doing it, all it would do is create an operational failure for the plan...

[Mike Preston]

Get up on the wrong side of the bed?  "should not be a state law"????  

[Tom Poje]

I guess the net effect,  you can intentionally beat the system by taking a loan and then defaulting. so much for no in service withdrawals of safe harbor contributions, etc.

[Mike Preston]

Well, there are loan limits, Tom.

[My 2 cents]

56 minutes ago, Mike Preston said:

Get up on the wrong side of the bed?  "should not be a state law"????  

As good an explanation as any!

[ewatson12]

So for FBJ, Mike Preston, and shERPA, if no specific state law requires the employee wishes to be followed in this regard, can the irrevocable promise be enforced?

[RatherBeGolfing]

15 minutes ago, ewatson12 said:

So for FBJ, Mike Preston, and shERPA, if no specific state law requires the employee wishes to be followed in this regard, can the irrevocable promise be enforced?

I don't know of any state where you can force an employee to deduct the loan payment from wages if they tell you to stop.  If you are going to do it, make sure you have a written opinion from an attorney who is specializes in labor law in your state.

Honoring the employees request will not result an operational failure for the plan (only a loan default for the EE), why risk a violation of state labor law  just to enforce an administrative option of the plan that is not required by ERISA?

[My 2 cents]

How do you get around the ERISA/regulatory mandate that in-service withdrawals can only be made if the hardship rules are met?  Statements from the loan recipient under penalty of perjury that they do not intend to convert the loan to a distribution by stopping repayments while employed?

[shERPA]

31 minutes ago, ewatson12 said:

So for FBJ, Mike Preston, and shERPA, if no specific state law requires the employee wishes to be followed in this regard, can the irrevocable promise be enforced?

If you want to enforce it, go ahead.  Maybe the employee will not object, loan payments will continue and life is good.  OTOH if the employee objects, what do you do, keep withholding and lawyer up to fight it?  Hardly worth the bother.  Only consequence of complying with the participant request to stop withholding is taxation to the participant.  

@My 2 cents - once you start applying some sort of cosmic justice standard to what laws "should" say, you're going to spend a lot of time tilting at windmills.   Best go into politics if you want to write laws.  But running on a platform of changing the law to prohibit employees from stopping payroll withholding of 401(k) loans is not going to get a lot of traction. 

[My 2 cents]

Just now, shERPA said:

If you want to enforce it, go ahead.  Maybe the employee will not object, loan payments will continue and life is good.  OTOH if the employee objects, what do you do, keep withholding and lawyer up to fight it?  Hardly worth the bother.  Only consequence of complying with the participant request to stop withholding is taxation to the participant.  

If the participant cannot afford to continue the loan repayments (as stated in the original post), how will they be able to afford the income taxes (and 10% excise tax) on the deemed distribution?  No getting out from under that, no matter what their financial situation may be.  The plan sponsor, without question, will report the resulting distribution to the IRS, and there will have been $0 withheld to cover those taxes.

[shERPA]

1 minute ago, My 2 cents said:

If the participant cannot afford to continue the loan repayments (as stated in the original post), how will they be able to afford the income taxes (and 10% excise tax) on the deemed distribution?  No getting out from under that, no matter what their financial situation may be.  The plan sponsor, without question, will report the resulting distribution to the IRS, and there will have been $0 withheld to cover those taxes.

Honestly, that's the participant's problem, not the plan's or plan sponsor's.  Maybe that sounds harsh, but it's still more or less a free country and people are free to make their own choices and decisions, even if they are not necessarily the "best" choices.  And who's role is it to determine what is "best" for a given participant in a specific situation?  Maybe he or she really needs money NOW for something important and is willing to deal with the consequences later. 

IRS offers payment plans and in more extreme cases OIC.