This a friendly reminder for plan sponsors: even if your 401(k) or 403(b) plan’s third-party administrator (TPA) handles participant transactions, you’re still ultimately responsible for the proper administration of plan loans and hardship withdrawals (considerations related to hardship withdrawal compliance are discussed here). In light of the IRS guidance that has been issued over the past year or so, as well as recent legislative changes concerning administration and documentation of plan loans, we’ve compiled a non-exhaustive list of issues to consider if your plan offers participant loans:
Is your documentation accurate?
Periodically review the terms of the plan regarding loans, the plan’s loan policy, and any description of plan loans in the plan’s summary plan description to ensure that the rules for plan loans are described accurately.
What is your TPA’s documentation process?
Confirm with the plan’s TPA that a process is in place to request the proper documentation from participants to substantiate a loan, and that another process is in place to retain this documentation (in paper or electronic format).
IRS guidance issued in 2015 listed the following documents that are needed and should be retained for each plan loan:
- Evidence of the loan application, review and approval process.
- An executed plan loan note.
- If a participant requests a loan with a repayment period in excess of five years, documentation obtained prior to the loan approval that the loan proceeds will be used to purchase or construct a primary residence.
- Evidence of loan repayments.
- If applicable, evidence of collection activities associated with loans in default and the related Forms 1099-R.
- Evidence of the actual distribution and the Form 1099-R that was issued.
Do loan administration procedures satisfy the requirements of the Code and ERISA?
The Code establishes requirements that a plan loan must meet in order to be a nontaxable distribution to the participant. ERISA and the Code include requirements that plan loans must meet in order to be exempt from the prohibition on the extension of credit by a qualified plan to a participant (who is considered a party in interest of the plan). Plan loans should be administered to comply with the following:
For a loan to a qualified plan participant to be a nontaxable distribution the loan must:
- Be repaid within five years (except for certain home loans).
- Require substantially level amortization (with payments made not less frequently than quarterly).
- Be less than the maximum loan limit specified in the Code (generally half of the participant’s vested account but in no event more than $50,000, with additional rules applying to a participant who has taken other plan loans within the preceding 12-month period). Note: The IRS issued a memorandum to its employee plans examination group discussing how plans can administer the maximum loan amount when the plan terms permit participants to have more than one outstanding loan. This guidance is available here.
- Be evidenced by a legally enforceable agreement.
Code §4975 and ERISA §406
For a plan loan program not to result in a prohibited extension of credit to a party in interest, loans made under the plan must:
- Be available to all participants and beneficiaries on a reasonably equivalent basis.
- Not be available to highly compensated employees in an amount greater than the amount made available to other employees.
- Be made in accordance with provisions provided in the plan or loan policy.
- Bear a reasonable rate of interest.
- Be adequately secured.
Has your plan implemented any of the relief provisions granted with respect to loans to participants affected by natural disasters in 2017?
If so, review whether the plan document (or the plan’s loan policy) needs to be amended for this relief, described briefly below:
Bipartisan Budget Act Relief
Applies to “qualified individuals” – participants who sustained an economic loss due to Hurricanes Harvey, Irma or Maria, or due to the California wildfires, whose principal place of abode was located in the disaster area on the applicable date(s) specified in the Bipartisan Budget Act, and who take plan loans during the applicable time period(s) covered by the relief. The relief provides for an increase in the maximum loan limit and possible 12-month suspension of plan loan repayments if certain requirements are met.
Plans are not required to offer this special disaster relief, but if the relief is provided, plans must be amended by the last day of the first plan year beginning on or after January 1, 2019 (January 1, 2021 for governmental plans).
Applies to qualified individuals, as well as participants whose place of employment was in the disaster area or whose child, parent, grandparent or other dependent lived or worked in the disaster area on the applicable date(s) specified in the IRS relief guidance, and who take plan loans during the applicable time period(s) covered by the relief. The relief allows plans to relax procedural requirements for loans (e.g., spousal consent, substantiation) for plan loans so long as the plan administrator took reasonable steps to obtain the required documentation as soon as possible.
If the plan did not include a plan loan provision but provided for plan loans in accordance with the relief, the plan must be amended by the last day of the plan year that begins after December 31, 2017. Otherwise, plans do not have to be amended to provide this relief.
Does your plan include a “cure period” for missed loan repayments?
If so, confirm that the plan’s cure period provisions are administered in accordance with recent IRS guidance. If not, you may want to consider adding a cure period.
Without a cure period, if a loan repayment is missed or paid after its due date, the loan is considered in default and the participant is considered to have received a taxable “deemed distribution” equal to the outstanding balance of the loan. However, the plan can provide that a loan default does not occur as long as the participant makes up the missed payment by the last day of the calendar quarter following the calendar quarter in which the installment was due (a shorter cure period can be used).
IRS guidance issued by the Office of the Chief Counsel provides two examples of how missed repayments can be fixed when the plan provides for a cure period. The examples are based on a loan taken on January 1, 2018, with the last repayment due on December 31, 2022, and assumes that the plan terms provide for the maximum cure period (i.e., the last day of the calendar quarter following the quarter in which the repayment was due).
Example 1 – Rolling Cure Period
The participant makes loan repayments from January 31, 2018, through February 28, 2019. The participant misses the payments due on March 31, 2019, and April 30, 2019, but makes payments on May 31, 2019, and June 30, 2019. The participant makes a payment equal to three payments on July 31, 2019.
The IRS guidance states that the missed repayments were cured with the applicable cure period (i.e., there is no deemed distribution of the loan) because each repayment was paid by the end of its applicable cure period:
Loan Payment Due Date
End of Applicable Cure Period
Date Loan Payment Is Made
March 31, 2019
June 30, 2019
May 31, 2019
|April 30, 2019||September 30, 2019||June 30, 2019|
|May 31, 2019||September 30, 2019||July 31, 2019|
|June 30, 2019||September 30, 2019||July 31, 2019|
July 31, 2019
December 31, 2019
July 31, 2019
Note: The rolling cure periods could continue until the end of the loan term (i.e., there is no requirement that eventually the missed payments are paid in a lump sum as in the example).
Example 2 – Refinancing
The participant makes loan repayments from January 31, 2018, through September 30, 2019. The participant misses the October 31, 2019, November 30, 2019, and December 31, 2019, payments. The end of the applicable cure period for all three missed payments is March 31, 2020. On January 15, 2020, the participant refinances the loan by replacing it with a new loan (the replacement loan) equal to the outstanding balance of the original loan, including the three missed payments. The replacement loan must be repaid in level monthly payments through the end of the original loan’s term, December 31, 2022. The three missed payments are considered paid as of January 15, 2020, when the replacement loan was taken. Therefore, the three missed payments were paid prior to the end of the applicable cure period.
Does your plan loan administration take into account the new timing requirements for rollovers of plan loan offset amounts that apply in certain circumstances?
A plan loan offset is a foreclosure on a participant’s account that occurs when the participant defaults on a plan loan, such as following termination from employment when a plan states that the loan becomes immediately payable in full and the loan is not timely repaid. When an offset occurs, the unpaid loan balance is deducted from the participant’s plan account (the loan is “offset”) and the amount of the loan offset is reported to the participant on a Form 1099-R as an actual distribution. However, a plan loan offset amount is treated as an actual distribution for rollover purposes and, if eligible, can be rolled over to an eligible retirement plan. Effective January 1, 2018, the Tax Cuts and Jobs Act extended the prior 60-day rollover period for plan loan offset amounts until the due date, including extensions, for filing the federal income tax return for the taxable year in which the offset occurs, in situations where the plan loan offset is due to plan termination or severance from employment.