I have to pay back 401k loan before I am eligible for re-hire?

[Jaclyn]

I was terminated from my job in July, however, I was told I am eligible for re hire as long as my 401k loans were paid back.  I have more money in my 401k than the loans that I borrowed.  I do not owe the employer the money, it was MY money that I was contributing to the plan, that I borrowed from.  Since I am unable to pay back the loan, I have to let it roll over as earned income in my taxes.  Why am i being told i have to pay back MY money before i am eligible to re apply and be considered for employment again with the same company. I could understand if I owed the company money, but it was my money.  Is this legal? (And I know, why fire me if you're just going to tell me "you're eligible for rehire..")

[BG5150]

I find that to be an odd request as a condition for re-hire.

[shERPA]

This might be prohibited under ERISA Section 510.  You are allowed to take a participant loan.  If your employment subsequently terminates, the loan is typically due and payable; if you default on the loan, it is a deemed taxable distribution.  None of this violates ERISA or the terms of the plan.  But then using the plan loan as a basis for a hiring decision would seem to cross the line.  Did they tell you this in writing?  Probably should seek legal advice, as IANAL.

From ERISA: 

Quote

It shall be unlawful for any person to discharge, fine, suspend, expel, discipline, or discriminate against a participant or beneficiary for exercising any right to which he is entitled under the provisions of an employee benefit plan . . . , or for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan

 

[david rigby]

You might want to read the plan and/or the SPD.  I think both will indicate that the loan is an investment of the plan; ie, it's the plan's money being loaned, not your money.

[fmsinc]

21 minutes ago, david rigby said:

You might want to read the plan and/or the SPD.  I think both will indicate that the loan is an investment of the plan; ie, it's the plan's money being loaned, not your money.

David:  Does the Plan get the interest on the loan payback?  I have never heard that to be the case.  The borrower loses market gains on the amount borrowed,  but the interest is paid back to and credited to the borrows 401(k).  I don't think it first passes through the Plan's bank account. That being the case, how can it logically be deemed to be an investment of the plan. 

You can call a horse a chicken, but it's still a horse. 

But wait.  I forgot that useful word "deemed" that would allow you to "deem" the horse to be a chicken without having to deal with the intellectual dishonesty of that assertion.  Are you are looking at para. (b) of  - https://www.law.cornell.edu/cfr/text/26/1.72(p)-1, and maybe Q-19 and A-19.  Or some other section? 

Madness!! - from Bridge on the River Kwai - 

 

[Luke Bailey]

This does not make sense to me either. It may be an honest misunderstanding of how the plan and the law work. I would ask the employer to point out what written document (plan, trust, loan policy, SPD) they are attempting to enforce. They will likely find nothing. If that fails, call the Employee Benefits Security Administration division of the U.S. Dept. of Labor and ask for its assistance.

[Larry Starr]

20 hours ago, fmsinc said:

David:  Does the Plan get the interest on the loan payback?  I have never heard that to be the case.  The borrower loses market gains on the amount borrowed,  but the interest is paid back to and credited to the borrows 401(k).  I don't think it first passes through the Plan's bank account. That being the case, how can it logically be deemed to be an investment of the plan. 

You can call a horse a chicken, but it's still a horse. 

But wait.  I forgot that useful word "deemed" that would allow you to "deem" the horse to be a chicken without having to deal with the intellectual dishonesty of that assertion.  Are you are looking at para. (b) of  - https://www.law.cornell.edu/cfr/text/26/1.72(p)-1, and maybe Q-19 and A-19.  Or some other section? 

Madness!! - from Bridge on the River Kwai - 

 

Does the plan get the interest on the loan? YES IT DOES. That's the law.  Now, how that return on investment gets allocated is another issue, and in many plans it is allocated back to the participant who borrowed the money.  In many of my plans (with no participant direction) it is not. It is simply another investment of the plan (it's a lot like a bond).

Our QP world is full of technical issues that are confusing to the lay individual (and rightfully so).  That's a good thing because that's why employers need people like us! (that's sarcasm).  Did you know that employee 401(k) deferrals are also NOT employee contributions?  Legally, they are EMPLOYER contributions.  And while that makes no sense at all to the  lay person, it actually makes perfect sense when you understand our convoluted tax laws.

[fmsinc]

I don't spend much time on this issue, but have always thought that you were paying interest to yourself (while knowing the down sides).  Perhaps I am simply naive, but

> https://www.listenmoneymatters.com/401k-loan/

“Borrowing against your 401K means, you are borrowing from yourself. Unlike borrowing from a bank, the interest you pay, you pay to yourself. The amount you borrowed is no longer invested so rather than getting investment gains; your “gain” is the interest you pay back.”

> https://www.investopedia.com/articles/retirement/08/borrow-from-401k-loan.asp

“Another confusing concept in these transactions is the term "interest." Any interest charged on the outstanding loan balance is repaid by the participant into the participant's own 401(k) account, so technically this also is a transfer from one of your pockets to another, not a borrowing cost or loss. As such, the cost of a 401(k) loan on your retirement savings progress can be minimal, neutral, or even positive. But in most cases, it will be less than the cost of paying "real interest" on a bank or consumer loan.”

> https://www.kitces.com/blog/401k-loan-interest-to-yourself-opportunity-cost-tax-rules/

“A unique feature of a 401(k) loan, though, is that unlike other types of borrowing from a lender, the employee literally borrows their own money out of their own account, such that the borrower’s 401(k) loan repayments of principal and interest really do get paid right back to themselves (into their own 401(k) plan). In other words, even though the stated 401(k) loan interest rate might be 5%, the borrower pays the 5% to themselves, for a net cost of zero! Which means as long as someone can afford the cash flows to make the ongoing 401(k) loan payments without defaulting, a 401(k) loan is effectively a form of “interest-free” loan.”

> https://www.thebalance.com/facts-about-401k-loans-2388811

“You will pay yourself interest: The interest rate on your 401(k) loan is determined by the rules in your 401(k) plan. The interest rate is typically set up as a formula, such as "Prime + 1%". You pay the interest back into your own 401(k) account balance.”

>  https://www.fidelity.com/viewpoints/financial-basics/avoiding-401k-loans

“One of the advantages of a 401(k) loan over other types of borrowing is that you pay yourself back with interest. One downside is that the interest may not keep pace with the potential investment return. You may miss out on potential market growth and investment compounding while some of your loan balance is outside the account and not invested.”

> https://www.finra.org/investors/learn-to-invest/types-investments/retirement/401k-investing/401k-loans-hardship-withdrawals-and-other-important-considerations

“On the plus side:

You usually don’t have to explain why you need the money or how you intend to spend it.

You may qualify for a lower interest rate than you would at a bank or other lender, especially if you have a low credit score.

The interest you repay is paid back into your account.

Since you’re borrowing rather than withdrawing money, no income tax or potential early withdrawal penalty is due.”

So I really don't get it.  No matter what fictions* may exist with respect to who is actually making the loan, and whose money is the source of funding for the loan, and who is receiving the interest on the loan,  it seems to me that the practical bottom line answer is that the account holder is borrowing from himself and is paying himself back with interest and that the interest is going to him as well.  N'est-ce pas?     

*Fiction - a belief or statement that is false, but that is often held to be true because it is expedient to do so.

David

[C. B. Zeller]

fmsinc - all of the links you posted describe one way of accounting for participant loans. This is a common way to do it, especially on daily valuation platforms where each participant's account is segregated from all others in the plan, and they all choose their own investments. These platforms are very popular and account for the vast majority of 401(k) accounts in existence today which is probably why all of the articles assume that is how the reader's plan is set up. In a pooled plan however a participant loan can be treated like any other plan investment, and the earnings on that investment (in other words, the interest paid on the loan) are just part of the plan's overall earnings for the year, which would be allocated to each participant's account in accordance with the plan's procedures for allocating earnings, which may or may not allow for interest on participant loans to be credited back to the account of the person whose account balance is securing that loan.

To the original question though, I wonder if the short period of time between the date of termination and re-hire has anything to do with it? If account only contains deferral contributions, the employer might not want to be in a position of distributing those contributions if the employee is under 59-1/2 and still employed at the time the loan is being offset. Jaclyn, the law allows (but employers are not required to provide) for a suspension of loan payments for up to 1 year during an unpaid leave of absence, with the missed payments during the unpaid leave to be made up upon return to work, or re-amortized over the term of the loan. I'm not sure if your situation fits this, but maybe they would allow you to make up just the payments that you missed while you were not working (with interest), and then resume payments on the original schedule?

[fmsinc]

Now THAT I understand.  Thank you kind sir. 

David

[ESOP Guy]

23 hours ago, fmsinc said:

I don't spend much time on this issue, but have always thought that you were paying interest to yourself (while knowing the down sides).  Perhaps I am simply naive, but

> https://www.listenmoneymatters.com/401k-loan/

“Borrowing against your 401K means, you are borrowing from yourself. Unlike borrowing from a bank, the interest you pay, you pay to yourself. The amount you borrowed is no longer invested so rather than getting investment gains; your “gain” is the interest you pay back.”

> https://www.investopedia.com/articles/retirement/08/borrow-from-401k-loan.asp

“Another confusing concept in these transactions is the term "interest." Any interest charged on the outstanding loan balance is repaid by the participant into the participant's own 401(k) account, so technically this also is a transfer from one of your pockets to another, not a borrowing cost or loss. As such, the cost of a 401(k) loan on your retirement savings progress can be minimal, neutral, or even positive. But in most cases, it will be less than the cost of paying "real interest" on a bank or consumer loan.”

> https://www.kitces.com/blog/401k-loan-interest-to-yourself-opportunity-cost-tax-rules/

“A unique feature of a 401(k) loan, though, is that unlike other types of borrowing from a lender, the employee literally borrows their own money out of their own account, such that the borrower’s 401(k) loan repayments of principal and interest really do get paid right back to themselves (into their own 401(k) plan). In other words, even though the stated 401(k) loan interest rate might be 5%, the borrower pays the 5% to themselves, for a net cost of zero! Which means as long as someone can afford the cash flows to make the ongoing 401(k) loan payments without defaulting, a 401(k) loan is effectively a form of “interest-free” loan.”

> https://www.thebalance.com/facts-about-401k-loans-2388811

“You will pay yourself interest: The interest rate on your 401(k) loan is determined by the rules in your 401(k) plan. The interest rate is typically set up as a formula, such as "Prime + 1%". You pay the interest back into your own 401(k) account balance.”

>  https://www.fidelity.com/viewpoints/financial-basics/avoiding-401k-loans

“One of the advantages of a 401(k) loan over other types of borrowing is that you pay yourself back with interest. One downside is that the interest may not keep pace with the potential investment return. You may miss out on potential market growth and investment compounding while some of your loan balance is outside the account and not invested.”

> https://www.finra.org/investors/learn-to-invest/types-investments/retirement/401k-investing/401k-loans-hardship-withdrawals-and-other-important-considerations

“On the plus side:

You usually don’t have to explain why you need the money or how you intend to spend it.

You may qualify for a lower interest rate than you would at a bank or other lender, especially if you have a low credit score.

The interest you repay is paid back into your account.

Since you’re borrowing rather than withdrawing money, no income tax or potential early withdrawal penalty is due.”

So I really don't get it.  No matter what fictions* may exist with respect to who is actually making the loan, and whose money is the source of funding for the loan, and who is receiving the interest on the loan,  it seems to me that the practical bottom line answer is that the account holder is borrowing from himself and is paying himself back with interest and that the interest is going to him as well.  N'est-ce pas?     

*Fiction - a belief or statement that is false, but that is often held to be true because it is expedient to do so.

David

I agree with C. B. Zeller those articles are written for the average person and they use language that makes sense to them.  In many ways it looks like you are paying interest to yourself but legally speaking it is paid to the plan and allocated to your account.

In my world the common way of explaining an ESOP is legally incorrect.  It is often times said you own stock in the company in your account.  For most purposes that is a good description but legally speaking all the stock in an ESOP is owned by the trust and the participants  are a beneficiary of the trust.  There just isn't much practical value in all the extra verbiage when doing an enrollment meeting so it is skipped and we talk about how the participants own the stock of the company.  

Even in a 401(k) plan we talk about how you are invested in this or that mutual fund like you own the mutual fund.  Legally speaking the trust owns all the assets and the participant is the beneficiary of the trust. 

The poor person who asked the original question getting hit with these technical side conversation! 

To that person I agree with the other people go talk to HR and see if there is some kind of misunderstanding as I have never in my decades seen a rule like you describing.  

[shERPA]

All this loan stuff is great for us pension geeks (well not really), but it isn't germane to the OP's question - what does the plan loan have to do with a hiring decision?   

It could be the OP misunderstood what the employer said, it could be that the employer doesn't know what they are talking about, or it could be that they don't want to rehire her and are using this as an excuse.  If the employer really told the OP that any hiring decision was contingent on repaying the loan, I still think this is a possible ERISA 510 violation.   

[Larry Starr]

5 hours ago, fmsinc said:

I don't spend much time on this issue, but have always thought that you were paying interest to yourself (while knowing the down sides).  Perhaps I am simply naive, but

> https://www.listenmoneymatters.com/401k-loan/

“Borrowing against your 401K means, you are borrowing from yourself. Unlike borrowing from a bank, the interest you pay, you pay to yourself. The amount you borrowed is no longer invested so rather than getting investment gains; your “gain” is the interest you pay back.”

> https://www.investopedia.com/articles/retirement/08/borrow-from-401k-loan.asp

“Another confusing concept in these transactions is the term "interest." Any interest charged on the outstanding loan balance is repaid by the participant into the participant's own 401(k) account, so technically this also is a transfer from one of your pockets to another, not a borrowing cost or loss. As such, the cost of a 401(k) loan on your retirement savings progress can be minimal, neutral, or even positive. But in most cases, it will be less than the cost of paying "real interest" on a bank or consumer loan.”

> https://www.kitces.com/blog/401k-loan-interest-to-yourself-opportunity-cost-tax-rules/

“A unique feature of a 401(k) loan, though, is that unlike other types of borrowing from a lender, the employee literally borrows their own money out of their own account, such that the borrower’s 401(k) loan repayments of principal and interest really do get paid right back to themselves (into their own 401(k) plan). In other words, even though the stated 401(k) loan interest rate might be 5%, the borrower pays the 5% to themselves, for a net cost of zero! Which means as long as someone can afford the cash flows to make the ongoing 401(k) loan payments without defaulting, a 401(k) loan is effectively a form of “interest-free” loan.”

> https://www.thebalance.com/facts-about-401k-loans-2388811

“You will pay yourself interest: The interest rate on your 401(k) loan is determined by the rules in your 401(k) plan. The interest rate is typically set up as a formula, such as "Prime + 1%". You pay the interest back into your own 401(k) account balance.”

>  https://www.fidelity.com/viewpoints/financial-basics/avoiding-401k-loans

“One of the advantages of a 401(k) loan over other types of borrowing is that you pay yourself back with interest. One downside is that the interest may not keep pace with the potential investment return. You may miss out on potential market growth and investment compounding while some of your loan balance is outside the account and not invested.”

> https://www.finra.org/investors/learn-to-invest/types-investments/retirement/401k-investing/401k-loans-hardship-withdrawals-and-other-important-considerations

“On the plus side:

You usually don’t have to explain why you need the money or how you intend to spend it.

You may qualify for a lower interest rate than you would at a bank or other lender, especially if you have a low credit score.

The interest you repay is paid back into your account.

Since you’re borrowing rather than withdrawing money, no income tax or potential early withdrawal penalty is due.”

So I really don't get it.  No matter what fictions* may exist with respect to who is actually making the loan, and whose money is the source of funding for the loan, and who is receiving the interest on the loan,  it seems to me that the practical bottom line answer is that the account holder is borrowing from himself and is paying himself back with interest and that the interest is going to him as well.  N'est-ce pas?     

*Fiction - a belief or statement that is false, but that is often held to be true because it is expedient to do so.

David

I didn't read all this, but you can read my article written quite a few years ago in the Journal of  Pension Benefits, which I've attached.  "Borrowing From Peter To Pay Paul".

BorrowingFromPeter.pdf

[C. B. Zeller]

ESOP Guy, thanks for pointing that out. If we're talking about fictions in the qualified plan world, the most pervasive one is easily that your 401(k) account is "yours," since it is of course, legally an asset of the plan under the control of a trustee. Given that the trustee is obligated to use that asset solely to provide benefits to benefits to you or your beneficiary, it is expedient (not to mention good marketing) to refer to it as "yours," but there are definitely situations where the distinction becomes important.

[fmsinc]

From a strictly legal perspective, a "trustee", whether individual or corporate, acts for and on behalf, and for the use and benefit, of the beneficiary/cestui-que trust.  The trustee, as a fiduciary, may be vested with administrative responsibilities and may be authorized to make investment decisions, but the trustee holds bare legal title for the beneficiary who is the equitable owner of the trust property.    

So it seems to me that no matter how one tries to look at the issue, a 401(k) Plan Participant owns the assets in his account, and if he borrows from that account he has removed his own assets, and when he pays the money back with interest he replenishes his own assets.  I have never fully understood the purpose of charging interest since it increases the value of the account and does not, or should not, enrich anyone else.  It is axiomatic that a trustee cannot appropriate the assets of the trust to himself. 

But I live in the QDRO world and I don't have to worry about fictions and non sequiturs and the often inexplicable workings of ERISA.  

Pax vobiscum.
    

[BG5150]

Larry, a few old things in there that we don't need to be worried about any more.  (S-corp officers and TLAs)

Do you still think participant directed accounts are "nonsense"?

[jpod]

Jaclyn, let's assume for the sake of argument that, even after further discussion the prospective employer REALLY does insist that the individual repay his plan loan.  I agree that the Section 510 argument has potential, but I have a feeling that any attempt to explain to the employer that he is violating the law is not going to end well.  He is likely to view that as you threatening a lawsuit if he doesn't hire you, even if you didn't intend to convey that.  

[David Schultz]

I'd like to highlight that in most plans, separation from service is a distributable event, and default results in a loan offset distribution vs. a deemed distribution.  If the loan has been offset, it may not be paid back (as the loan no longer exists).

[LIBERTYKID]

I would think the correct response is for the person to be told to speak to an employment law attorney. The attorney can consult with his/her benefits counsel if needed but I think the questioner has come to the wrong church. 

[Larry Starr]

5 hours ago, BG5150 said:

Larry, a few old things in there that we don't need to be worried about any more.  (S-corp officers and TLAs)

Do you still think participant directed accounts are "nonsense"?

Yes, I am aware of some vestigial organs in that one; but absolutely - participant directed accounts are nonsense for the vast majority of participants. And we have hundreds of plans that believe that as well.  Yes, I know we are different; that's what makes us so loveable! ?