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Should the plan’s administrator reverse the loan default?


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BenefitsLink neighbors, what do you think about this not-repaid loan story?

On February 13, 2023, the participant took a $10,000 loan.

The participant received the check and the promissory note, showing that her first payment was due on April 7, 2023.

The recordkeeper sent the loan file. The employer admits it erred in not uploading the loan file to payroll’s systems.

No loan repayment was taken from the participant’s wages.

On August 14, 2023, the recordkeeper sent the participant a letter informing her that, if she does not pay, her loan will default. The participant does not admit she received this letter. Yet, the address is the same address to which the $10,000 check was sent, and, one assumes, received—because the check was deposited.

The recordkeeper’s record shows the participant loan defaulted on September 29, 2023.

In early 2024, the participant received a Form 1099-R, reporting the unpaid loan.

The participant is 62, and works part-time. The plan treats the participant as not severed from employment. The plan does not provide a distribution on age 59½. The plan provides none of the SECURE 2019 or SECURE 2022 early distributions. The participant is ineligible for any further loan.

The participant asserts she has no computer. That includes lacking a mobile device beyond an old flip phone.

The participant asserts that she never looks at her pay confirmations.

The participant asserts that she was unaware of any problem about the loan until she received the Form 1099-R report.

The participant complains that she lacks money to pay even her Federal income tax (there is no State income tax) on the extra $10,000 income.

If the plan’s administrator (a committee of the employer) believes the participant’s statement that she did not notice any problem about the loan until she received the Form 1099-R, should the administrator direct the recordkeeper and trustee to reverse the loan default?

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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Obviously the employer was in error. But I don't believe the participant asserting that she doesn't look at her pay confirms. Anyone on a tight budget does. And anyone that is 62 and a Luddite, I guarantee is reconciling her checkbook constantly. She knew.

If I was the employer, I would let it stand. But I would offer to give her an employer loan of $X to cover the extra federal taxes to be paid back over the next year.

William C. Presson, ERPA, QPA, QKA
bill.presson@gmail.com
C 205.994.4070

 

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I have seen similar situations that fit this fact pattern and how each situation was resolved has varied.  There are four parties involved:  the participant, payoll, the recordkeeper, and the plan administrator.

Here the participant requested a loan and obviously received the loan check since the it was cashed.  I expect that the promissory note accompanied the check along with the comment that repayments would start on April 7, 2023 - and most likely said the repayments will start automatically by payroll deduction.  The April start date was 8 weeks after the loan was issued and, depending upon payroll cycles, the repayments could have started as much as 10 weeks after the loan date.  That is more than enough time for the start of loan repayments to be out-of-sight, out-of-mind for the participant.  (In one situation I have seen, the participant's spouse died between the date of the loan and the expected payroll start date and the participant certainly was not focused on the loan.)  In all of the situations, the participants took for granted that the company knew what it was doing and payroll was going to start taking loan repayments on time.  That argument becomes weaker over time, but the default date can arrive before the participant becomes sufficiently concerned to ask the company why payroll deductions have not yet started.  Certainly, receiving a default letter should at least triggered the participant to ask, but here it did not.

In all of the situations, the plan's loan policy required the loan repayments to be may through payroll.  Fundamentally, this is the root cause of the problem here and it is the participant who is suffering due to the failure of payroll to start taking the required loan repayments on time.  Under this policy, a participant's ability to repay a loan fully depends on payroll.  The IRS has acknowledged employers can be a root cause of loan failures as seen in Rev Proc 2021-30 6.07(3)(a).

The recordkeeper sent a letter to the participant about the pending loan default.  In most of the situations I have seen, the recordkeeper also sends a periodic report to the plan administrator listing loans with missed payments and also reporting the impending loan default date.  Some recordkeepers copied the plan administrator on the letter sent to the participant.  There is no mention here of any reporting from the recordkeeper to the plan administrator.  If such reporting already exists, then the plan administrator should share some responsibility for not taking action to have the loan repayments taken from payroll, and in effect protecting the participant from the consequences of the payroll failure.

In some of the situations I have seen, the recordkeeper is adamant that the default and 1099R are irrevocable.  Given that Rev Proc 2021-30 6.07(3) provides correction methods for loan failures, I find this position to be overly restrictive.  Further, we now have Notice 2023-43 regarding the availability for self-correction for certain inadvertent loan failures.  The notice comments:

"Section 305(b)(1) of the SECURE 2.0 Act provides that an eligible inadvertent failure relating to a loan from a plan to a participant may be self-corrected under section 305(a) according to the rules of section 6.07 of Rev. Proc. 2021-30, or any successor guidance, including the provisions related to whether a deemed distribution must be reported on Form 1099-R."

I offer these observations to highlight that in the situation described here, the participant suffers all of the consequences yet others were involved in the loan process and contributed to the participant's loan default.

I suggest exploring relief in this situation that may be available under SECURE 2.0 section 305 which may alleviate the consequences for the participant.

I suggest that the payroll, the recordkeeper and plan administrator discuss modifications to the loan administration and default procedures to address potential future such situations.  If robust reporting of missed loan repayments does not exist, I suggest the plan administrator should request the recordkeeper to prepare such reports preferably at least quarterly and include any participant who has any missed loan repayments. 

 

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