disallow deferrals until loan repaid

Small  (less than 100) 401(k) plan does not presently allow for loans - but would like to add them, subject to the hardship rules. 

they would like to restrict salary deferrals while a loan is being repaid. Meaning the participant cannot make deferrals until the loan is repaid in full. The thinking is that if the participant has extra cash available to make deferrals, then they should be using that extra cash towards the loan. 

i don't see anything on the face that would make this provision a problem - except a possible BRF issue. 

If loans are available only for hardship purposes, probably NHCE will be the primary users. If so, then the deferral restriction will primarily affect NHCE. HCE that do take a loan would likely have more means to repay it quicker. 

Am I over thinking this? 

Thoughts?

Should this provision be allowed?

How about the idea is confused and misguided thinking?  If the employer does not want to make the benefits of loans available, then don't rather than undercut the ability of the individual participants to make their own best plans with the resources they have available to them.  We might all agree that plan loans are often not the best alternative for an individual, all things considered, but I cannot accept that imposition of the employer's presumptions produces the best outcome for every participant.  In fact, I would argue that in many, if not most, cases, continuing elective deferrals rather than prepaying plan loans is a better financial move.  Even if the objective arguments are not persuasive, it is just offensive to have the employer presume to manage someone else's personal business at such a detailed level.  Is the plan designed to require the participants to direct investment of their accounts?  If so, how the employer reconcile that?  We all know that employees generally do not make optimal investment decisions.

I agree with you QDROphile. I guess the last sentence in the original post should have been worded better. 

I think this is a bad idea - there are plenty of times where I think certain provisions are a bad idea - But unless there is some compliance reason not to allow a provision, we usually help the sponsor amend their plan to work the way they want. 

But the question still remains - is this a permissible provision? Or is there some discrimination or compliance issue I'm overlooking? 

Are you an adviser or a scrivener?

I think it's a very bad idea and would not encourage it.  For one thing, paying back a loan can take up to 5 years (or longer).  They don't want people deferring for that long?? Who are they to decide this for the participant? Second, the loan payments have nothing to do with the employer, so why should they even get involved?  I have a plan who uses hardship reasons  to give loans, but they certainly aren't going to tell participants, ok now you can't defer until your loan is paid.

We are a scrivener. 

As to why the employer is involved - well the loan payments would be processed from pay, and the employer remits the payments to the trust. So the ER is involved every time a payment is made. 

Some employers are very traditional / paternalistic / conservative and this one clearly wants to discourage loans to the point where I think it is going to end up hurting NHCE. Allowing a provision that ends up hurting plan participants is counterproductive to me. 

How about just not allowing loans?

Whether or not it is legal is a question I'm not sure about but it does seem to add a great deal of needless complexity, in my humble opinion.

For NHCEs you are restricting them from making deferrals making it more difficult to pass ADP testing.

For HCEs you are basically saying you can't take a loan if you want to make deferrals. You are almost effectively saying HCEs can't take loans because most of them won't want to give up the tax deferred savings. Either way it is unlikely to make the employers most valuable employees happy.

If the Plan is a safe harbor 401(k), especially a safe harbor matching plan I think you have a problem with the provision as you are effectively restricting an eligible participant's ability to make deferrals and receive safe harbor match that is not an allowable exclusion.

Lastly if the plan allows catch-ups anyone with a loan now has an effective deferral limit of $0.00 so if they are over age 50 even if you say they can't make regular deferrals, you have to allow them to make catch-up contributions.

All and all it sounds like a bade idea to me but if you can make it work, more power to you.

I wouldn't go along with it unless an ERISA attorney is involved.  Seems a clear violation of the 2550.408b-1(a)(1)(i), the requirement that loans be available to all participants on a reasonably equivalent basis and for the same reason that loan minimums in excess of $1,000 are not allowed.

If that cite doesn't float your boat, then keep reading until you get to 408b-1(a)(3).

One of those will surely kill this bad idea.

Would something like that take the doc out of prototype/VS status?

Most assuredly.

On 4/5/2018 at 7:00 PM, Mike Preston said:

I wouldn't go along with it unless an ERISA attorney is involved.  Seems a clear violation of the 2550.408b-1(a)(1)(i), the requirement that loans be available to all participants on a reasonably equivalent basis and for the same reason that loan minimums in excess of $1,000 are not allowed.

If that cite doesn't float your boat, then keep reading until you get to 408b-3.

One of those will surely kill this bad idea.

 

Mike,

Did you mean 408b-1(a)(3)?  408b-3 is ESOP loans.

On 4/5/2018 at 7:00 PM, Mike Preston said:

I wouldn't go along with it unless an ERISA attorney is involved.  Seems a clear violation of the 2550.408b-1(a)(1)(i), the requirement that loans be available to all participants on a reasonably equivalent basis and for the same reason that loan minimums in excess of $1,000 are not allowed.

If that cite doesn't float your boat, then keep reading until you get to 408b-3.

One of those will surely kill this bad idea.

 

No, it is a stupid idea on its face, and most likely not permissible.  If the client really insisted, I would suggest that they go for a ruling on it, which they won't do because of the cost.  We would certainly talk them out of this stupid idea!

2 hours ago, Larry Starr said:

Mike,

Did you mean 408b-1(a)(3)?  408b-3 is ESOP loans.

Indeed! Thanks. Corrected.

If the employer doesn’t want to administer loan repayments AND contributions at the same time, do loan repayments through ACH/electronic banking.  Not sure why they would limit loan access to hardship reasons, unless they don’t offer hardship withdrawals today, or if they expect to eliminate hardship withdrawals in 2019 due to the coming changes that are part of the recent Budget Act.  

It also looks like prohibiting deferrals while a loan is outstanding would violate the universal availability requirement for catch-up contributions in 1.414(v)-1(e) when a catch-up eligible participant takes a loan.  Even if they get past the other hurdles mentioned, do they want it bad enough to take catch-up contributions away from everyone?