Making it possible for participants to take a loan from their retirement accounts is a common plan feature. But it also is not unusual for mistakes to be made concerning those loans. A recent article, as well as the IRS, offer some suggestions regarding how to identify and fix them, as well as avoid them altogether.
In “How to Find, Fix and Avoid Plan Loan Mistakes,” an article appearing in The Newport Group’s Second Quarter edition of their PlanFacts newsletter, the authors argue that mistakes with plan loans are all but inevitable. “Administering plan loans typically involves multiple people from several organizations, including your human resources staff, your payroll provider, and a third party administrator or recordkeeper. Mistakes are bound to happen,” the write.
Avoiding Plan Loan Mistakes
An ounce of prevention is worth a pound of cure, says the old maxim. Archaic, perhaps, but nonetheless true — avoiding a mistake in the first place is preferable to having to address one. The authors observe that the IRS in its 401(k) Plan Fix-It Guide advises, “Plan sponsors should ensure that their plan document allows loans before allowing participants to borrow money from the plan. Some plan documents include a complete description of loan rules. Others make only a statement that the plan allows participant loans, subject to a separate written loan program.”
The IRS suggests that the following may be helpful in avoiding plan loan mistakes:
- a system for determining the participant’s maximum loan amount during the loan approval process;
- a written policy used to determine the loan terms;
- written, enforceable loan agreements;
- loan procedures that provide for a cure period which allows the plan administrator a window of time to get a payment from the participant without it being considered a missed payment;
- documentation for exceptions to general rules;
- procedures for monitoring timely repayment;
- procedures for analyzing deposits;
- procedures for the plan’s record keeper to allocate the appropriate amounts to the participants’ loan balances; and
- accurate software for determining loan limits and repayment amounts.
The IRS suggests that plan loan mistakes can be found by reviewing the loan agreements and loan repayments to verify they have met the Internal Revenue Code Section 72(p) rules to prevent the loans from being treated as taxable distributions. This review, they say, should include:
- Determining whether there are written loan agreements for outstanding loans. If not, the loan is a taxable distribution to the participant.
- Reviewing the terms of each loan agreement to ensure that it meets the rules required to prevent the loan from being treated as a taxable distribution.
The authors note that the IRS offers a way to fix plan loan mistakes through its Employee Plans Compliance Resolution System (EPCRS), and that now certain mistakes may be corrected through the IRS Self-Correction Program. To do that, they write, an employer must have practices and procedures that are designed to promote overall compliance with applicable IRS rules. They add that if a defaulted loan presents any prohibited transaction concerns, they must be addressed by through the IRS Voluntary Compliance Program.