Loan payroll deduction did not start

[K-t-F]

A participant took a loan from the plan and the payment was supposed to be withheld from their payroll.  The payment was not.  Besides getting the deduction going so that the loan is paid back, what is the remedy for the lost time... missing payments?  

[Bird]

How many payments?  If one or two...or a few, probably just start now and move on.  They'll always be a bit behind schedule but as long as it's not going to cause a default, not much happens.

[K-t-F]

No... not just a few.  We are talking months.  I should have mentioned that in the original post.  

[rr_sphr]

do those missed months cause the original amortization schedule to go over the 5 year boundary (or the longer purchase of a primary residence/mortgage boundary)?  Does the employee have the ability to double up payments to make up for the lost ones?   There are some solutions here, but it's going to depend on how long and how much....

 

[K-t-F]

It has  been 1 year almost to the day.  Re-calculating the loan so that it is paid off on time ... is that an acceptable solution?  I struggle with this whole debacle because it is not the participant's fault.  I mean, the payroll administrator dropped the ball by not starting the deduction.    

[rr_sphr]

does that 1 year late push them beyond the 5 year boundary? I've had discussions with my TPA about best loan practices and that is to shorten the max length so that leaves and other periods give some timing grace.  I don't have a cite for it though.  

Does your plan allow for re-financing or more than one loan  (where you pay off one with the new one)?

If it's been a year, the employee should have noticed no loan repayments coming from their check and yes, either HR or payroll should have done some reconciling throughout the year to catch this MUCH sooner (we review loan repayments every payroll period and then quarterly payroll deductions against the recordkeeping system) -- but I say this as a benefits AND payroll person who is now an HR manager.

[loserson]

First, check the plan document.  If it addresses this situation, it likely says this is a deemed distribution.

The plan can have a cure period for missed loan payments, but the cure period must not be longer than the last day of the calendar quarter following the quarter in which the last timely payment was made.  After the cure period ends, loans not being repaid are deemed distributed.

So if the participant took out a loan in AUG 2018 and no payments were ever made, the first payment was due in Q3 2018 and the maximum cure period ended on 31 DEC 2018, the last day of Q4 2018.  After Q4 2018 ended with no repayment, the loan is deemed distributed as of the first missed payment.  If the plan has no cure period, then the loan is still deemed distributed as of the first missed payment.

The plan needed to issue a 1099 this past JAN/FEB 2019 for the deemed distribution.  The participant's 2018 taxes will probably have to be amended to account for the income from the deemed distribution.

The employer could choose to make the employee whole or give some kind of special bonus for tax relief.  The employer could possibly pursue some kind of service credit with whichever vendors accept blame.

Frankly, most of the parties involved bear some blame here, including the employee - who apparently never noticed the loan repayments were not coming out?  It's unfortunate that the employer, the payroll vendor, and the plan vendors all failed to catch this earlier, and it's a failure of process overall.  But the employee also failed and as the only person personally at stake, is arguably the one most responsible for watching that paychecks and the 401(k) plan balance are correct.

There is an exception for leave of absence, where you can miss payments up to a year, so long as the loan is still fully repaid in the 5-year term (with a more aggressive payment schedule).

See Treas Reg § 1.72(p)-1, Q/A-10

Quote

 

Q-. 10. If a participant fails to make the installment payments required under the terms of a loan that satisfied the requirements of Q&A-3 of this section when made, when does a deemed distribution occur and what is the amount of the deemed distribution?

A-10. (a) Timing of deemed distribution. Failure to make any installment payment when due in accordance with the terms of the loan violates section 72(p)(2)(C) and, accordingly, results in a deemed distribution at the time of such failure. However, the plan administrator may allow a cure period and section 72(p)(2)(C) will not be considered to have been violated if the installment payment is made not later than the end of the cure period, which period cannot continue beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.

 

See also CCA 201736022 on a Section 72(p) loan cure period.

Or see IRS 401(k) Plan Fix-It Guide on plan loans.

The payroll vendor usually is not in a position to check who has 401(k) loans.  The sponsor and the 401(k) plan vendor(s) will have access to the list of loan-holding participants and are in a better position to check regularly whether those loans are being repaid.

The payroll vendor probably messed up the initial deduction instruction, or maybe the employer messed up by not correctly issuing the instruction to the vendor. And then nobody at the employer double-checked that the instruction was followed by the payroll vendor.

The plan sponsor and the plan vendors appear to have messed up for a year by not monitoring whether 401(k) loans were all being actively repaid.

The employee messed up by not checking paychecks and not checking the 401(k) to see that everything was being done correctly, or messed up by not understanding that the plan loan should have been repaid.

Plenty of blame to go around.

[Belgarath]

Take a look at Revenue Procedure 2019-19, Section 6.07(3)(d). This may help you out.