Stopping Loan Payments while still employed

I have a participant who has said he would like to stop loan payment withholding from his check because he can no longer afford them and treat it as a taxable distribution.  My first thought is he can't while he is still employed there.  The loan paperwork (which I have not been able to lay my eyes on since new plan in transition to us) should state that it is an irrevocable pledge and conditional upon payroll deduction repayment.  As the plan sponsor, I would think they could not just stop collecting the repayments since it is their job to ensure repayment to the plan.  My next idea is to explore a hardship to pay off the remainder of the loan but I am waiting on the participant to express an immediate and heavy financial burden in one of the safe harbor instances.

Thoughts on the ability of the plan sponsor to stop withholding the payments?  I would think this would be prohibited  transaction land.

I suppose it depends on state law.  Here in California the employer is forced to follow the employee's wishes.  If that results in a default, so be it.

Agree with MP it's a state law issue and same result in Virginia.

This is an issue where ERISA does not preempt state law because there's nothing in ERISA that requires plan loan repayments from wages or when any such voluntary withholdings can be revoked.

Some lawyers read ERISA Advisory Opinion 94-27A (July 14, 1994) to suggest some reasoning under which ERISA might preempt a State’s wage-payment law.  https://www.dol.gov/agencies/ebsa/employers-and-advisers/guidance/advisory-opinions/1994-27a

For preemption to apply, Federal law need not regulate the same subject or object as what the State law regulates.  Under ERISA’s express preemption, ERISA’s titles I and IV supersede a State law “insofar as [the State law] may . . . relate to any [ERISA-governed] employee benefit plan[.]”  ERISA § 514(a), 29 U.S.C. § 1144(a).

Further, a participant-loan procedure’s or other governing document’s provisions about repayment of a participant loan might be a part of a plan’s ERISA § 402(b) funding policy.

A lawyer rendering advice about whether a State’s wage-payment law is or isn’t preempted might consider ERISA § 514(b)(4):  “Subsection (a) shall not apply to any generally applicable criminal law of a State.”  (Before ERISA § 514(e), some lawyers interpreted § 514(b)(4) as undoing a preemption that otherwise might apply if the State’s law made it a crime to violate the State’s wage-payment law.)

Relevant law’s several (and compound) ambiguities suggest an employer needs its lawyer’s advice.  (If the plan’s administrator is a person distinct from the employer, it too might need its lawyer’s advice.)

Consider that a too-hasty decision in either direction risks a breach or violation.

Honoring the participant’s request to stop payroll deduction cannot possibly be considered a violation of any provision of ERISA or the Code.

Not honoring the participant’s request may very well give rise to state law cause of action.

Seems like any easy decision.

I've also had this come up a few times over the year.  Here in California, I agree with Mike Preston and FBJ. 

ERISA § 404(a)(1)(D) states:  “[A] fiduciary shall discharge his duties with respect to a plan . . . in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of this title and title IV.”

This might apply if each State law that otherwise could restrain the employer’s deduction from the pay of a participant who asked to stop the deductions is preempted.  (I don’t suggest that a fiduciary must follow a plan’s governing document if doing so would be a violation of an unpreempted State law.)

I recognize that many employers make practical choices about this intersection between Federal and State laws.

Something else to consider, does the plan do loan re-financing?  For example, if an employee takes a new loan for $1, and re-finances the old loan into the new loan, that would allow him to extend the remaining loan balance (plus $1) out to the maximum loan repayment period which would probably lower his payment amount to a more affordable number.  (Don't forget to apply the loan rules as to the max available when re-financing out to a period longer than the original due date.)

No refinancing, only 1 loan permitted.

I can't seem to find anything in reference to state law as some of the early posters mentioned.  It is an Alabama based plan

Not a lawyer, not an expert on 401(k) loans, but...

Isn't the idea that administrators of ERISA plans are not required to be conversant with the laws of numerous states, ergo ERISA preempts state laws?  What is a plan with active participants in 35 states supposed to do, administer the repayment of loan provisions 35 different ways?

The best approach would probably be put something explicit in the plan document concerning the handling of such requests (absolutely not or whatever the participant wants, with favorable determination letters having been obtained for the plan document) and follow it without regard to the laws of the state the participant lives in.  If it's a prototype, there ought to be a yes or no checkbox in the adoption agreement concerning the ability of participants to stop making required repayments.  State laws cannot require that the provisions of a federally regulated pension plan be violated, due to ERISA preemption. 

The handling of loan repayment requirements in 401(k) plans should automatically be treated as outside the scope of state wage payment laws.  Those should not be treated as deductions from wages the way salary reduction amounts to generate 401(k) employer contributions are.

Much too simplistic.  I think the standard or question is whether the state law has a material impact on the administration of an ERISA plan.  By definition this means a facts and circumstances determination.  And payroll procedures are generally considered to be the subject of state labor laws.  I suppose the logic is that since the employer has to understand the payroll laws of those states it operates in in order to do payroll, there is, at most, an ancillary impact on plan administration.

56 minutes ago, My 2 cents said:

Isn't the idea that administrators of ERISA plans are not required to be conversant with the laws of numerous states, ergo ERISA preempts state laws?  What is a plan with active participants in 35 states supposed to do, administer the repayment of loan provisions 35 different ways?

Well, that isn't quite how preemption works.  Think of it more like if ERISA requires something to be done, it would most likely preempt a state law to the contrary.  But every provision in a plan document is not an ERISA requirement.  Loans have to be repaid, but ERISA does not require that the loan be repaid by payroll deduction.  Drafting a plan document requiring that the loan be repaid by payroll deduction does not preempt state labor law, it just means that it is the only option provided to the participant to repay the loan,  and that the participant will default on the loan if payroll deduction is stopped.

I'd be curious to know in what state you could say "I'm sorry but you have to maintain this otherwise optional deduction from your pay."  None, I believe.

RBG beat me to it - this is an administrative requirement, not an ERISA requirement, IMO.

I have trouble seeing the deduction to repay the loan as "optional".  Agreeing to payroll deductions was a condition precedent to receiving the loan in the first place.  If the participant signed an agreement to repay the loan based on a specified repayment schedule (to be handled via payroll deductions), there should not be a state law that would interfere with the terms of that agreement  being carried out, and unless the loan agreement gives the participant the right to cease making repayments at will, the participant should be treated as bound by the agreement to repay.

If forced to allow the loan recipient to stop repaying this loan, the sponsor ought to consider amending the 401(k) plan to prohibit such a choice for all future loans.  If the participant cannot afford to repay the loan, it should be considered from the start as a withdrawal (and subject to all in-service restrictions on withdrawals).  401(k) plans are not supposed to be used to pay current  expenses (except for permissible hardship situations) - they are supposed to stay in place to provide retirement income/assets.

24 minutes ago, My 2 cents said:

If the participant signed an agreement to repay the loan based on a specified repayment schedule (to be handled via payroll deductions), there should not be a state law that would interfere with the terms of that agreement  being carried out, and unless the loan agreement gives the participant the right to cease making repayments at will, the participant should be treated as bound by the agreement to repay.

It is clearly not preempted by ERISA since ERISA does not require repayment by payroll deduction.  I struggle to justify why an agreement made between employee and employer should carry more weight than state law.  

24 minutes ago, My 2 cents said:

If forced to allow the loan recipient to stop repaying this loan, the sponsor ought to consider amending the 401(k) plan to prohibit such a choice for all future loans. 

To prohibit what choice?  Payroll deduction altogether?  I guess they could amend the plan to say you can't stop your payroll deductions, but since they can't actually prohibit the participant from doing it, all it would do is create an operational failure for the plan...

Get up on the wrong side of the bed?  "should not be a state law"????  

I guess the net effect,  you can intentionally beat the system by taking a loan and then defaulting. so much for no in service withdrawals of safe harbor contributions, etc.

Well, there are loan limits, Tom.

56 minutes ago, Mike Preston said:

Get up on the wrong side of the bed?  "should not be a state law"????  

As good an explanation as any!

So for FBJ, Mike Preston, and shERPA, if no specific state law requires the employee wishes to be followed in this regard, can the irrevocable promise be enforced?

15 minutes ago, ewatson12 said:

So for FBJ, Mike Preston, and shERPA, if no specific state law requires the employee wishes to be followed in this regard, can the irrevocable promise be enforced?

I don't know of any state where you can force an employee to deduct the loan payment from wages if they tell you to stop.  If you are going to do it, make sure you have a written opinion from an attorney who is specializes in labor law in your state.

Honoring the employees request will not result an operational failure for the plan (only a loan default for the EE), why risk a violation of state labor law  just to enforce an administrative option of the plan that is not required by ERISA?

How do you get around the ERISA/regulatory mandate that in-service withdrawals can only be made if the hardship rules are met?  Statements from the loan recipient under penalty of perjury that they do not intend to convert the loan to a distribution by stopping repayments while employed?

31 minutes ago, ewatson12 said:

So for FBJ, Mike Preston, and shERPA, if no specific state law requires the employee wishes to be followed in this regard, can the irrevocable promise be enforced?

If you want to enforce it, go ahead.  Maybe the employee will not object, loan payments will continue and life is good.  OTOH if the employee objects, what do you do, keep withholding and lawyer up to fight it?  Hardly worth the bother.  Only consequence of complying with the participant request to stop withholding is taxation to the participant.  

@My 2 cents - once you start applying some sort of cosmic justice standard to what laws "should" say, you're going to spend a lot of time tilting at windmills.   Best go into politics if you want to write laws.  But running on a platform of changing the law to prohibit employees from stopping payroll withholding of 401(k) loans is not going to get a lot of traction. 

Just now, shERPA said:

If you want to enforce it, go ahead.  Maybe the employee will not object, loan payments will continue and life is good.  OTOH if the employee objects, what do you do, keep withholding and lawyer up to fight it?  Hardly worth the bother.  Only consequence of complying with the participant request to stop withholding is taxation to the participant.  

If the participant cannot afford to continue the loan repayments (as stated in the original post), how will they be able to afford the income taxes (and 10% excise tax) on the deemed distribution?  No getting out from under that, no matter what their financial situation may be.  The plan sponsor, without question, will report the resulting distribution to the IRS, and there will have been $0 withheld to cover those taxes.

1 minute ago, My 2 cents said:

If the participant cannot afford to continue the loan repayments (as stated in the original post), how will they be able to afford the income taxes (and 10% excise tax) on the deemed distribution?  No getting out from under that, no matter what their financial situation may be.  The plan sponsor, without question, will report the resulting distribution to the IRS, and there will have been $0 withheld to cover those taxes.

Honestly, that's the participant's problem, not the plan's or plan sponsor's.  Maybe that sounds harsh, but it's still more or less a free country and people are free to make their own choices and decisions, even if they are not necessarily the "best" choices.  And who's role is it to determine what is "best" for a given participant in a specific situation?  Maybe he or she really needs money NOW for something important and is willing to deal with the consequences later. 

IRS offers payment plans and in more extreme cases OIC.  

19 hours ago, ewatson12 said:

So for FBJ, Mike Preston, and shERPA, if no specific state law requires the employee wishes to be followed in this regard, can the irrevocable promise be enforced?

It's an irrevocable pledge and assignment, not an irrevocable promise to continue to pay by payroll deduction.

As a condition of the loan, independent of the payroll deduction mechanism, the plan can require an assignment of wages under state law concerning creditor security.  The assignment has to be done at the inception of the loan and must be in accordance with state law, e.g. UCC and community property laws.  One might wonder if a plan administrator is required to take such precautions to prevent the loan as a scam to get around the in-service distribution proscriptions (mentioned by others above as a troublesome aspect of voluntary renunciation of authorization of pay withholding).

Those interested in this discussion's observations about which State laws ERISA preempts or does not preempt might consider a recent U.S. Supreme Court decision about the reach of ERISA's preemption.  While the factual context is quite different, the opinions describe some interests in 'nationally uniform plan administration', and disagree about how much a State law may interfere.

https://www.supremecourt.gov/opinions/15pdf/14-181_5426.pdf

Again, I don't state a particular conclusion; only that an employer (and a plan administrator if not the same person) should get its lawyer's advice.

There was a recent Montana ruling on a matter of a conflict between state law and the plan concerning divorce and beneficiary rights.  In that case, the spouse was named as beneficiary under an ERISA life insurance plan.  The participant and spouse were divorced and no action was taken to change the life insurance beneficiary (when is there ever?).  State law terminated spouse's interest in such benefits upon divorce.  After the divorce, the participant changed his will to name his two children as being entitled to the entire estate. When the participant died, both the ex-spouse and a daughter filed suit claiming the insurance proceeds. 

As reported in the October 20 BenefitsLink  newsletter, the court ruled in favor of the ex-spouse, saying in effect that to administer the ERISA plan, the plan administrator needs to follow the terms of the plan and should not have to worry about state laws that may conflict with the plan provisions.  It was not clear whether there was diversity of state residence involved, but it would not appear that if all parties lived in Montana that the court would have ruled differently.

As a general rule, ERISA preemption exists so that a plan sponsor need not hire a battery of attorneys to make sure that various state laws are being followed.  The case cited by Fiduciary Guidance Counsel above involved a national insurance company (whose employee health plan had participants and beneficiaries in all 50 states) fighting against having to isolate claim date for Vermont residents and reporting that information, to enable Vermont to judge whether state law rules for health plans should be changed.  I am trying to remember - can states impose specific coverage requirements on ERISA health plans or is that sort of authority preempted?

38 minutes ago, My 2 cents said:

ERISA preemption exists so that a plan sponsor need not hire a battery of attorneys to make sure that various state laws are being followed.

No. 

55 minutes ago, RatherBeGolfing said:

No. 

Are you saying "no" to the idea behind ERISA preemption (to facilitate a highly desirable uniformity of administrative practices between jurisdictions) or to the question as to whether states can require specific coverages under an ERISA health plan?

It has always been my understanding that ERISA preempts most state laws so that similarly situated participants in different states can be administered exactly the same way.  A company doing business in a particular state should not have to handle a claim differently just because a participant has retired and moved to a different state.  That would place an excessive burden on the plan administrator.

13 minutes ago, My 2 cents said:

Are you saying "no" to the idea behind ERISA preemption (to facilitate a highly desirable uniformity of administrative practices between jurisdictions) or to the question as to whether states can require specific coverages under an ERISA health plan?

I'm saying no, preemption does not exist so that you can ignore or disregard state law.  Preemption exists because federal law is supreme, and conflicts with state law is resolved in favor of the federal law.  ERISA also expressly prohibits state law from governing an employee benefit plan.  A state law requiring specific coverage under an ERISA health plan is preempted because it sought to govern an employee benefit plan.  

The issue in our thread is not as clear-cut.  There is no ERISA requirement that the loan has to be repaid via payroll deduction.  A state law prohibiting an employer from disregarding an employee direction to stop withholding from their pay governs payroll (or possibly employee rights), it does not govern employee benefit plans.  

Is it possible that a court could apply general or express preemption so broad that it would preempt a state payroll law that does is not in conflict with an ERISA requirement?  Sure, it is possible.  But absent that, I would not advise a client to disregard state law because of the general principle of preemption.  

1. My 2 Cents said earlier: "How do you get around the ERISA/regulatory mandate that in-service withdrawals can only be made if the hardship rules are met?"

The Service has said this isn't an issue. 1.72(p)-1, Q&A 12:

"Q-12: Is a deemed distribution under section 72(p) treated as an actual distribution for purposes of the qualification requirements of section 401...?

A-12: No; thus, for example, if a participant in a money purchase plan who is an active employee has a deemed distribution under section 72(p), the plan will not be considered to have made an in-service distribution to the participant in violation of the qualification requirements applicable to money purchase plans. Similarly, the deemed distribution is not eligible to be rolled over to an eligible retirement plan and is not considered an impermissible distribution of an amount attributable to elective contributions in a section 401(k) plan. See also § 1.402(c)-2, Q&A-4(d) and § 1.401(k)-1(d)(5)(iii)."

2. As to the general issue, this has been debated forever (as can be seen by the number of topics devoted to it here). I don't have much to add to the above, except that 1.72(p)-1, Q&A 19 requires that after a default, subsequent loans must be repaid by payroll deduction pursuant to an agreement "enforceable under applicable law." However, this is conditioned on the following: "For this purpose, an arrangement will not fail to be enforceable merely because a party has the right to revoke the arrangement prospectively."