Loans from 401(k) Were for More Than 50% of Vested Balance; How to Fix?

On Jan 1, 2024 we implemented a loan policy that allows a loan on the amount of 50% of vested balance not to exceed $50k.  When our recordkeeper updated the system to reflect the new loan policy, they did not include the 50% of vested balance part.  We had 12 employees in 2024 take out loans in excess of the 50% of their vested balance.  Some loans were 90% or more of the vested balance.  This is 100% fault of the recordkeeper as they have admitted.   What recourse do we have against the recordkeeper?  What options for corrections do we have.  The recordkeeper showed us one option where the participant will have 60 days to pay back the excess or it will deemed a distribution.  Has anyone else experienced this type of failure?

https://www.irs.gov/retirement-plans/fixing-common-plan-mistakes-plan-loan-failures-and-deemed-distributions

You could talk to the record keeper about paying for the cost associated with a VCP filing. It's possible in this case that IRS might even allow the loans to stand as is if most are to NHCEs and do not exceed the 5 year repayment period, the errors is shown to be the fault of the recordkeeper's system, and that future loans are limited to 50% of vested balance.

Remember that there might be two bodies of law to meet, not only tax law but also ERISA’s title I.

Under tax law, there might be an I.R.C. § 72(p) failure, a § 4975 nonexempt prohibited transaction, and a § 401(a) failure to administer the plan according to the written plan.

Under ERISA, there might be a § 406(a) nonexempt prohibited transaction, and a § 404(a)(1)(D) breach of not administering the plan according to the documents governing the plan.

Read EBSA’s 2025 Voluntary Fiduciary Correction Program to consider whether there might be an opportunity to coordinate tax law and ERISA corrections. https://www.govinfo.gov/content/pkg/FR-2025-01-15/pdf/2025-00327.pdf

Consider whether a failure was an “eligible inadvertent failure” and, if so, what opportunities SECURE 2022 § 305(b) might allow.

Get the advice of a lawyer who’s independent of the recordkeeper.

Although ordinarily a lawyer doesn’t accept a fee from a payer other than the lawyer’s client, one of the recognized variations is payments under an indemnity obligation.

This is not advice to anyone.