Participant Loans: Key Considerations

Editor’s Note: This is the second article in a two-part series on participant loans. Retirement Services Compliance at Newfront shares the insights and suggestions of her manager, Joni Jennings.appear first here.

Many retirement plans allow participants to take out loans from their accounts. But it’s not enough to simply decide what to allow participants, it’s just the beginning. There are steps that must be followed and important considerations that arise from that initial selection.

Below, Joni Jennings, Retirement Services Compliance Manager at Newfront, said that an employer “401(k)ology — Participant Loans (Part 1)

Impact of deemed distribution of loans on the system

Jennings notes that as long as the loan is outstanding, the plan is indebted, and the participant is an employee, the balance is an asset of the plan. This is important, she says. Because, in most cases, active participants have not yet earned the right to receive a distribution, and participants must repay the loan.

Jennings continues that whether or not a participant can get an already outstanding loan depends on whether the plan allows it. But plan fiduciaries need to be careful, even if the loan policy allows participants to take out more than one loan at a time. Because giving a loan delinquent participant her second loan could be seen as circumventing the distribution provisions.

Whether it’s wise to grant a second loan to an active employee who has delinquent loans probably depends on the facts and circumstances, she said. Jennings said it “may be wise to indicate in the loan policy that if a participant is in arrears on a loan, the application may be denied if the participant is in arrears on another loan. No,” he suggests.

Repayment by active participants with loans considered taxable

Jennings points out that active participants who have loans that are considered taxable not only can repay the loans, they have an obligation to do so. Loan repayments are considered “after-tax,” and must be tracked separately to ensure participants are not double taxed on the same distribution, she notes.

forced loan repayment

Jennings writes that if one of the conditions under which a loan is made to a participant is that the repayment be made through after-tax payroll deductions, the plan’s trustee must collect the repayment.

But there are complications, Jennings says. Circumstances such as state law may prevent such repayment arrangements. Also, in states where ERISA does not preempt state laws on voluntary payroll deductions, employers must stop it at the employee’s direction.

Other Trustee Considerations

Jennings said the IRS, through its role in taxation and working with participants, and the Department of Labor, through its role in enforcing rules on prohibited transactions and fiduciaries, have a role in enforcing rules on participant loans. increase.

Participant loans must be reported on the plan’s Form 5500, Jennings observes, and warns that if the plan reports a deemed distribution, the plan may be more likely to be audited.

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