Attorney Advises Ways To Handle Recurring Loan Administration Problems

Reprinted with permission of Thompson Publishing Group

An attorney who has seen many recurring problems in plan loan administration recently explained how to handle them in an interview with the Guide. Arris Murphy, an ERISA attorney and consultant with The Vanguard Group, noted that delinquent loans seem to plague most every plan. The problems range from loan repayments that were initiated on a delayed schedule, to loan repayments that are off schedule and will not complete by the loan termination date, to loans that reflect several missed payments. The administrator should first determine why loans repayments are not on schedule for active participants, and then identify and implement the appropriate action to get the loan repayments on schedule.

Vanguard processes well over 150,000 plan loans annually for its qualified plan clients, Murphy noted. So while its experience is not necessarily representative of what other administrators have faced, it is instructive in the variety of potential problems that may arise. Below are a few of the causes for loan delinquencies that plan sponsors should monitor to avoid the challenge of getting such loan repayments back on track.

Delayed Deductions

A delay in initiating the loan repayments is one type of loan delinquency. In this scenario, the participant receives and cashes the loan check, but the participant’s paycheck does not reflect timely deductions of scheduled payments. Administrative or clerical error may account for the delay, or there may be another reason. Either way, no repayments are made. Therefore, the loan administrator reports loan payments that are off schedule, and will not be completed by the loan termination date.

Insufficient Pay

Another delinquency occurs when an employee’s paycheck is insufficient to cover standard payroll deductions, and deductions for elective deferrals and loan repayments respectively. Generally, the hierarchy of deductions lists loan repayments last. Here, the service provider reports an occasional missed payment, which will eventually cause the participant’s loan to become delinquent.

Leave of Absence

IRS regulations allow suspension of loan payment obligations for up to a year (except military leave, which may be longer) when an employee is on a bona fide leave of absence (see ¶434 of the Guide). Nonetheless, the missed payments will cause the loan to appear as a delinquency. When an employee with an outstanding loan returns from a leave of absence, most plan sponsors reamortize the remaining loan balance within the original loan term. While the new repayment amount increases, the loan is back on schedule and will pay off within the allotted period, Murphy noted. When an employee who took a leave does not timely return to work, the loan is generally treated as a deemed distribution, and becomes taxable income to the employee.

Appropriate Corrections

IRS guidance is clear with respect to resolving loans for those who take standard and military leave of absences; and the Department of Labor provides guidance for correcting loans for an incorrect amount or time period. Yet, short of treating the loan as a deemed distribution, neither provides examples similar to the other scenarios described above. It is important to note that when correcting loans for which no guidance exists, plan sponsors should make every effort to closely align proposed corrections with IRS and DOL guidance.