Loan Payoff After Plan Termination?

[metsfan026]

We have a plan that's suddenly terminating in a few weeks.  One of the participants have an outstanding loan that they want to payoff, prior to taking a distribution.  Does that have to be done prior to the Plan Termination, or can they pay it off via personal check a few weeks after the Plan Termination date?

This is one I haven't run into before.

Thanks in advance!

[Bri]

I'd think no issues, just like any ongoing plan other than maybe the termination distribution is looming faster where you don't want an RK to discharge a defaulted loan as everything else is getting distributed.

[Paul I]

This situation is not uncommon when a plan termination is effective with little or no advanced notice, and as @Bri comments, there are transactions related to the termination that will take time to be processed properly.  Consider, for example, that a lot of activity may occur after the official plan termination date such as:

• contributions due to the plan may be deposited after the plan termination,
• distributions require giving a participant 30-day notice to decide on a rollover (unless the participant waives the notice period). 
• there may be missing or lost participants that need to be found to be able to close out the plan,
• and, in this case if the plan document permits, participants with loans may wish to pay off the loan.

Keep in mind that a terminated plan will continue to have responsibilities until the assets go to zero.

 

[Peter Gulia]

And consider making the documents governing the plan fit what the plan’s sponsor will allow.

[fmsinc]

Bri:  I don't recall reading anything in  metsfan026's post suggesting that the loan was in default.  How are you defining "default"?  

What does it mean when a plan "terminates"?   Are there DoL regulations setting forth the steps in the process, and is the timing or the protocol set forth in the Plan Documents?  I am pretty sure that the account balances survive the "termination".  They don't disappear...poff....do they?   

Or are the account balances immediately distributable as taxable income to each Participant?  No?  I wouldn't think so.  

Do the Participants have a time frame within a rollover can be made to the Participant's IRA or other eligible retirement account?  Or to elect a taxable distribution? 

Doesn't a Participant with an outstanding loan balance have until payments are due to make the payment...or payments that may stretch into the future?  I would think so.   Or does the "termination" automatically accelerate all of the loan payments due?  

I read these posts in the hope of reaching enlightenment with respect to the administration of ERISA plans. Why?  Because my legal involves the preparation of QDROs for divorcing couples and the amount of outstanding loans can impact the amount available to pay the Alternate Payee the amount or percentage awarded to her.  In 40 years of preparing QDROs I have never had to consider Plan termination as a factor that I needed to address in the QDROs I prepare or as a factor for the parties should consider in drafting their Marital Settlement Agreement or that the Court should address in the Judgment of Absolute Divorce.  

Do I need to add, e.g.

"In the event that the Plan shall terminate prior to  full payments of the amount awarded to the Alternate Payee in this QDRO it shall be conclusive be presumed that all outstanding loans have been or will be paid in full by the Participant prior to computing the amount payable to the Alternate Payee."   

I found this article, but it doesn't deal with outstanding loans the Plan termination. 

https://www.milliman.com/en/insight/pension-plan-data-plan-termination-clean

Aspects of this issue were addressed on BL in June, 2024 at -

And I just discovered https://www.dol.gov/node/25154

where the DoL says:

 "In drafting orders dividing benefits under defined contribution plans, parties should also consider addressing the possibility of contingencies occurring that may affect the account balance (and therefore the alternate payee's share) during the determination period. For example, parties might be well advised to specify the source of the alternate payee's share of a participant's account that is invested in multiple investments because there may be different methods of determining how to derive the alternate payee's share that would affect the value of that share. The parties should also consider how to allocate any income or losses attributable to the participant's account that may accrue during the determination period. If an order allocates a specific dollar amount rather than a percentage to an alternate payee as a shared payment, the order should address the possibility that the participant's account balance or individual payments might be less than the specified dollar amount when actually paid out.

Reference: ERISA §§ 206(d)(3)(C); IRC § 414(p)(2)"

But no explicit mention of plan termination.  

David

[mming]

Though the participant wants to pay off the loan, no mention was made whether the loan paperwork allows for pre-payment - hopefully it does, at least in the event of a plan term.

[David D]

When a plan terminates, the loan becomes due.  Since the plan no longer exists, as it is an investment of the trust, all trust assets are distributed to close out the plan.  The loan is an obligation of the participant and is non transferable, but I have seen on occasion that the QDRO attorney specifies how the split is determined when loans are involved.

[Bri]

The loan paperwork may also have a "payable on demand" clause to it to cover such a situation where the plan's trust is going away to let the participant know there's not going to be a loan any longer.  That too should easily establish a default date (and I acknowledge to @fmsinc that the loan wouldn't yet be in default but eventually that bell will toll for the participant to pay up sooner than expected).

[C. B. Zeller]

Has anyone explained to the participant that there is literally no point to doing this?

Here’s the math to prove it. Let’s say we have a plan account balance (exclusive of the loan) of $300,000, and a $25,000 loan outstanding. Participant currently has $25,000 in their bank account, which they plan to use to pay off the loan.

If they don’t repay the loan:

300,000 distribution 
+ 25,000 loan offset
= 325,000 total taxable event 

25,000 already in bank account
+ 235,000 cash distribution (300,000 minus 20% withholding on the 325,000 total taxable distribution)
= 260,000 in bank account after distribution 

Now for the other situation, if they did repay the loan before the distribution, now they have $0 in the bank and $325,000 in their plan account.

325,000 distribution is the total taxable event

Less 20% withholding, the cash received by the participant is 260,000.

Exact same tax consequences, and exact same cash situation both ways.

If they wanted to do a rollover instead of a cash distribution, again it’s the same result. Because the loan offset was the result of a plan termination, it is a Qualified Plan Loan Offset, which means it can be repaid to the participant‘s IRA after the fact - as late as their personal income tax filing deadline.

[fmsinc]

Might I point out that a D/C loan is NOT a loan at all.  The Participant is borrowing from himself and is repaying himself with interest.  The interest goes directly back into the Participant's account. See https://www.fidelity.com/viewpoints/financial-basics/taking-money-from-401k

It is not like taking out a loan from a bank where you have someone else's money.  A D/C loan is akin to taking $20 from the cookie jar on Monday and putting $21 back into the cookie jar on the following Monday. 

Unless you have some authority, please don't tell me that a D/C loan comes from the "Plan" that holds the accounts of all of the Participants and that there are no individual accounts for each Participant.  Every Participant has a vested interest in the plan - just like a partnership, notwithstanding that all of the assets and liabilities of the partnership are in the name of the partnership and not in the separate names of each partner.  

 See https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-vesting

“Vesting” in a retirement plan means ownership. This means that each employee will vest, or own, a certain percentage of their account in the plan each year. An employee who is 100% vested in his or her account balance owns 100% of it and the employer cannot forfeit, or take it back, for any reason."

David

 

 

 

[David D]

@fmsincDavid - That is true with 401k plans that are primarily now on a record keeping platform where each participant can log in at anytime to see their account balance.  But that was not true before 401kl plans became popular, nor true for those employers that have not added a 401k but simply have a trustee directed DC plan.  In those plans, usually a TPA does the accounting once a year, or quarterly on paper, but the money is still all in one pool that everyone shares proportionately in the gains/losses of the trust.  In those instances the interest is not credited back to the participant, but goes in to the trust and everyone shares proportionately.  Currently in our office I would say about 25% of our plans still operate that way.

If you prefer not to refer to it as loan, it is money that the participant was able to take out of the plan as a tax free distribution and pay it back over time.  In the event the plan terminates, the loan becomes payable in full, and if not paid back, the tax free distribution now becomes taxable.