Frozen 401(k) Plan/Participant Loan Issue

A CPA/Auditor friend of mine came up with these two questions today. First, she is auditing a 401(k) Plan that has been "frozen" since January 1, 2020. The reason for the freeze was to correct operational defects in the plan from 2017-2019; which, after she described it, was failure to complete compliance testing and make appropriate refunds to HCE's. Her question was whether the plan should be considered terminated, due to lack of contributions for 3 years (still frozen as of today); my thought is that perhaps the Plan Sponsor (still a viable company and not subject to closing or bankruptcy) froze the plan to avoid 100% vesting on the matching contributions going into the plan. My response to her was to question the plan sponsor as to whether, once the defects are corrected, was going to unfreeze the plan and let deferrals resume. Otherwise consider formally terminating the plan. Any thoughts on this?

And second, a participant took a $50,000 loan in June, 2022 for the purchase of a principal residence, payable over 30 years. However, the house was purchased in December, 2021 and closed in February, 2022. Isn't this out of order? And then the participant "refinanced" the loan in September 2023. And, just to make it more interesting, the participant is the owner of the company.

Thanks for any replies. I'm both a TPA and a CPA/auditor, and these are 2 questions that made me scratch my head.

Just a few quick thoughts.

1 hour ago, bzorc said:

The reason for the freeze was to correct operational defects in the plan from 2017-2019

Here's the first red flag for me! Did they have a TPA at any point prior to her involvement? Were any corrections ever made, to the defects she identified or to others? The fact that they froze the plan and then evidently did nothing else worries me. I don't know how the plan administrator or another fiduciary would explain the decision to freeze the plan (which is not a correction) to buy time to correct defects, then not take steps toward any substantive corrective action for several more years. Of course there may be more going on behind the scenes, but that's my initial reaction.

I think your response to her is a good one. Find out what they want to do, then worry about how much of it is reasonable or even possible. In any case, neither "just leave it frozen" nor "terminate and hope nobody looks closely" are good options, as you know!

My general sense is there is more going on with this plan than is visible to either of you at the moment. Digging in at the level required to prepare, say, a VCP filing is probably going to uncover more issues. The project could end up being considerably more involved if they'd like to keep the plan as a going concern; I think you'd need to make a strong case to the examiner that the significant operational defects have been addressed at the administrative/"process" level and that they won't be seeing a similar filing a few years from now for the same kinds of problems.

1 hour ago, bzorc said:

And second, a participant took a $50,000 loan in June, 2022 for the purchase of a principal residence, payable over 30 years. However, the house was purchased in December, 2021 and closed in February, 2022. Isn't this out of order?

Honestly, that issue is probably the least concerning part of the post to me! I'll give a "definite maybe" on this one. At a glance I think it could be fine depending on circumstances and documentation, assuming the loan satisfies the plan and IRS requirements aside from this question. There's some good, fairly recent discussion at:

For what it's worth, I'd bet at least a dollar or two that this loan has other problems as well.