Plan loans issued at interest rate below the rate in the Plan Document

[Guest Gary Stadtmauer]

A 401(k) Plan document requires that Plan loans be issued at an interest rate Prime plus two percent. The new Plan Trustee issued Plan loans at an interest rate equal to prime. Upon discovering the error, the Plan loans were reamortized using the correct interest rate and the Plan's participants were asked to pay the back interest based on the Plan's required rate. One Participant refuses to pay the back interest ($24.00) claiming that it was the Trustees error and they should pay the back interest.

What would be the result if:

The Trustee did pay the back interest?

Nothing was done to collect the back interest but all future payments used the correct rate?

Is there any way to force the Participant to pay the back interest ?

[Guest PAUL DUGAN]

If the participant is non highly compensated I would forget about it. You and the trustee have already spend more than 24 dollars of time on it. If he is highly comp. I would talk about plan disqualification and ask him how he would like to pay tax on his entire account balance or call the loan in default and send him a 1099 for the loan balance.

[Guest Kevin Plymyer]

Why does your plan document state a defined interest rate? I thought the DOL recommended the interest rate chosen should be consistent with interest rates charged by commercial lenders for a loan made under a similar circumstance. Am I mistaken?

As for the participant not wanting to pay back the interest, I agree with Paul. I would also remind the participant that the loan interest goes into his account, so he is increasing his own balance.

[Guest mo again]

I would have the trustee pay the back interest only if the loans are not directed investments. If loans are not directed investments, future interest is also an issue for the trustee. You may have trouble changing the interest rate paid by the participant now if the plan is subject to truth-in-lending and disclosed a different rate. Consumer law will hold you to the lower rate, as I recall from some recent research on this issue.