What’s 12.5% of 60 million? A lot—and that’s the approximate number of retirement plan participants who have outstanding loans against their savings. ERISA experts point out that “a lot” also represents the administrative errors made related to loans. Here’s what plan sponsors need to know—and do, when it comes to retirement plan loans.
Attorneys at Foley & Lardner encourage awareness of the retirement plan loan rules and regulations of the IRS and the Treasury and stress that plan loans must be considered taxable distributions “unless they satisfy these rules”:
- Loans must be permitted by the plan document2and should be available to all participants and beneficiaries on a reasonably equivalent basis.
- Loans must be evidenced by a legally enforceable agreement (either in hard copy or electronic format3).
- Loans can’t exceed the lesser of (a) 50% of the participant’s vested plan account balance or (b) $50,000.4The maximum loan amount will be reduced by the outstanding balance on any prior loan(s).
- Loans must be secured by the vested assets in the participant’s plan account and provide for a commercially-reasonable interest rate.
- Loans must be repaid through substantially level repayments on at least a quarterly basis.
- Loans must generally be repaid within five years (exceptions may apply for loans used to purchase a primary residence and to address certain leaves of absence).
Loan errors, such as missed payments, defaults and exceeding the maximum term, as well as a participant having multiple loans at the same time, are among the most common types of mistakes ERISA specialists encounter with employer sponsored retirement plans. Fortunately, the government provides various correction methods. For example, failure by a participant to repay a loan, if “the maximum loan repayment period hasn’t expired” may be corrected by:
(i) the participant making a lump sum payment to the plan equal to the missed loan payments, plus interest;
(ii) re-amortizing the loan’s outstanding balance, including any accrued interest, over the remaining term of the original loan or over the maximum loan period permitted by the Code Section 72(p) (measured from the loan’s origination date); or
(iii) a combination of (i) and (ii).
Of course correcting loan errors requires timely detection, which is why retirement plan experts encourage plan sponsors to conduct operational reviews, ideally annually. Timeliness is of the essence, as Genelle Brakefield, a vice president at third-party administrator Ekon Benefits points out: “If you don’t look, you don’t know what’s going on….The nice part about doing these assessments frequently is that the faster you can identify a problem, the faster you can fix it… Speed is our friend, in this case.” Because compliance mistakes are always a possibility, another prudent practice for retirement plan sponsors is obtaining Fiduciary Liability Insurance. With this, for a few dollars a day, you’ll have coverage for defense costs and penalty limits up to $1,000,000 if faced with alleged or actual breaches of duty in connection with the employee retirement plan. Cyber Liability coverage is included at no extra cost, providing additional protection against regulatory actions related to data and privacy, as well as expert response services.
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While it is possible to correct errors involving loans against retirement savings, it is of course best to avoid mistakes in the first place. Toward that end, the IRS provides guidance, which Foley & Lardner have summarized into these three key points for plan sponsors:
- take care when establishing a 401(k) plan loan program, including carefully reviewing any required forms, loan policies, and other documentation;
- implement a system for monitoring the administration of the loan program, requesting periodic reports from plan vendors, and spot-checking loan paperwork to ensure ongoing compliance with IRS requirements; and
- Identify and correct any administrative errors as quickly as possible.
Plan sponsors wondering how to begin a review of plan operations can start with the 401k Plan Fix-It Guide provided by the IRS. Keep in mind too that implementation of the comprehensive new SECURE 2.0 legislation over the next several years brings new compliance responsibilities for retirement plan sponsors. It is important for plan sponsors to understand that although contracts with service providers can reduce the risk of personal liability for a breach, this risk can never be fully eliminated. As Richard Clarke, a national risk managment expert points out:
Realistically, even with diligent effort, plan sponsors will make mistakes. 2022 was the second most active year on record for ERISA litigation against plan sponsors….Unfortunately, plan sponsors bear personal exposure for third-party claims of not meeting fiduciary obligations…Some plan sponsors think if they outsource administration, oversight, or supervision of employee benefit plans, that they’re also outsourcing the liability. The liability exposure in that instance is the decision that’s made to utilize third party services. Fiduciary liability insurance is an indispensable measure to ensure sponsors and their businesses are protected with defense costs and penalty limits.
Colonial is here to help with a reasonably priced and easy to obtain fiduciary+cyber liability package specifically tailored for plan sponsors. With lawsuits, cyber threats and regulatory compliance issues all on the rise, why take chances with your savings? Put the protection you deserve in place today:
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