Participant Loan w/ Wrong Interest Rate

Plan uses Prime + 1% normally.  We made a boo boo where we did a loan for someone but just forgot to add 1% to Prime (Prim was 5.25%).  I've never run into this before.  What would the correction look like?  OR I am also floating a threory that Prime is not an unreasonable rate so maybe there is no correction at all.

Or maybe we need to pay him 50% of the additional interest he would have accrued from inception to date?  What about going forward?  Why should he agree to a refinancing to "fix" the rate if his promissory note says 5.25%?

Fascinating topic!

 I would pretend that I didn't notice it.  Seriously.  We go to great lengths to do things right the first time, but stuff happens, and in this case, fixing it involves a chain reaction of corrections that is, shall we say, unpleasant, and the error is trivial, IMO.  If "caught" on audit I'd say "huh, I guess we messed that up" and I doubt there would be any consequences.  

Not to agree or disagree, but it was caught by the CPA auditors

So then the Q is, what do they want you to do about it?  That's kind of my point, if not "caught" you can either go to a great deal of trouble voluntarily, or you can wait and see what "they" want you to do about it, which might be nothing other than a slap on the wrist, or it might be the same "great deal of trouble."  If it turns into a worse scenario I'd like to know.

1 hour ago, austin3515 said:

Not to agree or disagree, but it was caught by the CPA auditors

Those CPAs and their sticklers for numbers!  (This is coming from a CPA by the way.) 

Unless the auditor is requesting a "fix", my argument would be to let it stay the way it is.  The reasoning being that Prime is not an unreasonable rate, even if the plan normally uses Prime +1.  It would be different if there could be a presumption that the rate is unreasonable, like 15% or 1%.

Well I have referred to a "pension celebrity" who answers questions through a service and he says that we need to pay him the difference between the two rates cumulatively because he was harmed from a fiduciary perspective (we're talking peanuts here).  Then he said we can ask the participant to re-execute a new promissory note with the corrected interest rate.  But if he declines (which I don;t think will be a issue for this one) we should probably pay all of the difference.  Anyway, that's what he said.  And again the dollars involved are so small (and the client is so good) that I'm inclined to do that.  He said failure to follow the established loan procedurs was a problem and somehow he felt pretty strongly that there PT issues here as a result.

He also indicated quite rightly that if this was an HCE there would be other problems as well because of the requirement that loans be available on a similar basis for all employees (that doesn't apply in my case thankfully...

1 hour ago, austin3515 said:

he says that we need to pay him the difference between the two rates cumulatively because he was harmed from a fiduciary perspective (we're talking peanuts here)

Then I'd turn around and bill the participant for the money he saved.  Sounds silly to me, peanuts or no.  Is it a celebrity like a Kardashian or a celebrity like Stephen Hawking?

I don;t like to use his name on these boards because I feel like his answer was private and it wouldnt be appropriate for me to represent that my regurgitation of his answer was his answer.  Plus he gets paid to give advice so it feels a little pickpockety.

1 hour ago, austin3515 said:

I don;t like to use his name on these boards because I feel like his answer was private and it wouldnt be appropriate for me to represent that my regurgitation of his answer was his answer.  Plus he gets paid to give advice so it feels a little pickpockety.

I think we can all guess who it is based on the details above 

 So my previous answer shall henceforth be read as "what that guy said".

You are free to speculate

Is the Recordkeeper (if there is one) willing to go back to day 1 and adjust the loan interest; and then have the overage pay down the principal?

austin3515, the issue is whether the interest rate is reasonable. Because the plan uses prime + 1 for everyone else, and intended for this participant, prime is, at least arguably, per se unreasonable. This is not a qualification error or a 72(p) problem, but if the interest rate is unreasonable it is a PT for IRC 4975 and ERISA 406(a). Therefore you would need to correct in accordance with those provisions. The amount of tax owed under 4975 (15% of 1% of the loan amount, divided by 12 and multiplied by the number of months the loan has been outstanding) will almost certainly be too small to actually file the 5330. Probably just a few dollars. The DOL won't want you to do VFCP for such a small amount either. So just get the participant to agree to change the rate and your done. Participant can make up the lost interest in next payment, which again will probably only be a few dollars.