Missed Participant Loan Repayments
A recent PLANSPONSOR article, When a Participant Loan Falls Through The Cracks, discusses how to fix a default when repayments have been missed. Below is brief summary:
What are the consequences if a plan sponsor neglects to start making repayments after a participant takes a loan?
“Under Internal Revenue Code (IRC) Section 72(p)(2), a participant who has taken a 401(k) loan must pay it back in level, at least quarterly, installments by their due date. Otherwise, the loan goes into default—the result being the Internal Revenue Service (IRS) will treat it as a deemed distribution, subject to tax.”
The participant will still need to make up the missed installments (this part of his account will not be taxed again, on final distribution). Lastly, the IRS may require the employer to pay a portion of the tax if the company’s negligence caused the default. +
How do you correct the error?
“Some plans allow for a “cure period” as permitted under IRS modifications to Section 72(p). If the one in question does, depending on plan provisions, the participant may have as long as until the end of the calendar quarter following the one in which the first installment was missed to correct the error. If not, the loan is in default from the first missed payment.”
The IRS recommends that retirement plans, at the start of each month, “reconcile the aggregate payroll deposits to the plan (employees’ elective contributions and loan repayments) with the payroll amounts that should have been deposited to the plan. If there are gaps, then payroll records, election forms and loan documents should be analyzed on an individual basis to determine whether the correct amounts—including loan repayments—were withheld from the employees’ paychecks and deposited into the plan.”
If the plan has no provision for a cure period, or if the cure period has elapsed, the plan administrator may seek relief under the IRS Voluntary Correction Program (VCP).
- Contact firstname.lastname@example.org if you have any plan correction issues or questions. BPP has a reputation for “fixing broken retirement plans.”
How do you prevent the error?
As stated in the article, “the IRS suggests that retirement plans establish a policy whereby payroll must confirm it knows a loan is being made– i.e. an authorized person must sign-off the approved loan application form– before the plan can write a check. The agency also advises the plans to adopt a cure period, as that gives the administrator at least a window of time to correct an issues before a loan defaults.”