Participant loans - Promissory Note

[Santo Gold]

Most recordkeepers we work with (we are a TPA) allow for online loans.  Their procedure does not appear to have a separate online Promisssory Note for the participant to complete.  

Curious if anyone else still prepares the promissory note in these situations or not.

Thank you

[Peter Gulia]

The Treasury’s rule looks for “a legally enforceable agreement”, and says it may be “a document that is delivered through an electronic medium under an electronic system that satisfies the requirements of § 1.401(a)-21[.]” And: “The agreement does not have to be signed if the agreement is enforceable under applicable law without being signed.”

26 C.F.R. § 1.72(p)-1/Q&A-3(b) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR807fc2326e73cb3/section-1.72(p)-1

Consider that for many plans “applicable law” might be ERISA’s title I, which supersedes a State’s law.

And under other Federal law, a signature, contract, or other record may not be denied legal effect, validity, or enforceability solely because it is in electronic form, or because it was formed using an electronic signature or electronic record. 15 U.S.C. § 7001(a).

“The term ‘electronic signature’ means an electronic sound, symbol, or process, attached to or logically associated with a contract or other record and executed or adopted by a person with the intent to sign the record.” 15 U.S.C. § 7006(5).

So, a mouse-click on an I-accept button might be an electronic signature that makes a legally enforceable agreement to repay the participant loan.

Still, I’d like to read the answers to Santo Gold’s query.

[Lucky32]

I always considered a promissory note to be a document that clearly spells out a participant's legal obligation to the plan when borrowing, the parameters of the loan (interest rate, repayment frequency, duration, etc.), and the consequences of what happens when repayments aren't done in a timely manner (as well as how and when a default occurs).  So it would seem to be a necessity IMO.

[QDROphile]

I have no argument about use of a promissory note as best practice. A promissory note is a device that facilitates enforcement/collection as a matter of civil procedure. It is not essential for creation of a valid, enforceable obligation to pay. As suggested by Lucky32, it is taken for granted in commercial lending practice, which is the standard for plan loans. So why would a fiduciary not employ one?

[Peter Gulia]

Let’s ask some related questions.

Of individual-account retirement plans that provide participant-directed investment and provide participant loans, with a loan affecting only the plan account of the borrower,

and considering whether there likely will be an effort, beyond wage deductions and adjustments in the individual’s account, to collect on a loan:

When deciding whether and how to collect is in a plan fiduciary’s discretion, how many plans’ fiduciaries put in an extra effort to collect on a participant loan?

When deciding whether and how to collect is a subject of a participant’s power and responsibility of investment direction, how many participants direct a plan’s trustee, administrator, or other fiduciary put in an extra effort to collect on a loan the participant doesn’t want to repay?

How often does it happen that having, beyond a legally enforceable agreement to repay, a distinct document in the form and style of a promissory note gets an efficiency in collecting on a participant loan?

Could a plan’s administrator loyally and prudently decide not to incur a plan-administration expense to make and keep promissory notes because the expense might be more than the incremental value the plan would obtain from having the notes?

[Artie M]

Not sure what all recordkeepers do but I have dealt with two recordkeepers, large ones, recently on issues that involved loans and can pass on this information.  All loan participants who take a loan under the plans that they recordkeeper receive a promissory note that they do not have to sign nor do they have to return.  It is part of the loan confirmation notice that they receive after taking the loan.  We reviewed the promissory notes and they contained all the information required under the §72 regs (and the state laws that were applicable under our facts) for a valid promissory note, and we (and the recordkeepers) believe that they were legally enforceable.  Of course, those were our circumstances and I have no idea if all the requisites will be met in your instance.

 

 

[fmsinc]

The reality is that the participant is borrowing his own money and will pay it back to himself with interest. It is not a "loan" in the classical meaning of that word.  It is more akin to taking $20 out of the cookie jar in the kitchen on Monday and paying $21 back on the following Monday. 

A promissory note is a legal instrument under the uniform commercial code and carries with it all sorts of rights, duties and obligations that seem out of place in your situation.

I agree with Peter that all you need is some written acknowledgment of the obligation to repay the money. And that isn't even true if The participant decided to terminate his employment and turn the "loan" into a taxable distribution.

 

 

 

 

 

[Peter Gulia]

My experiences are that a recordkeeper’s online regime to apply for a participant loan includes delivery of a document that’s labeled a loan agreement and promissory note. That document is delivered online, with a paper print available if the individual asks for it. That document gets an electronic signature in the recordkeeper’s system. Further, the document states that the payee’s deposit or negotiation of a check, or acceptance of an electronic funds transfer, is assent to the loan agreement and promissory note.

I express no view about whether that might or might not be a promissory note that would make more efficient a civil action to collect on a loan.

[thepensionmaven]

My experience has been that some record keepers ask the participant to complete a loan application and send out a check.  That’s it.

I am proactive in my approach by attempting to ask myself what an auditor will be looking for if the plan is subject to audit.

In my role as an ERPA I handle many IRS audits of plans with loans; an auditor of plan with loans has always asked for a loan document, collateral pledge and assignment, as well spousal consent if the loan is over $5000 and of course an amortization schedule 

Of course, the auditor looks to see that not only is the loan being repaid as well in accordance with the amortization we provide.

IMHO, better to be prepared in advance.