The IRS recently released a snapshot of the problem (the “Instantaneous”) Focusing on loans to pension plan members and where certain compliance errors could trigger deemed distributions in respect of those loans. Specifically, the snapshot lists the following requirements which, if not met, will result in a participant loan being treated as a deemed distribution:
- Requirement of a binding agreement, which generally requires that a participant loan be a legally binding agreement (which may include more than one document) and that the terms of the agreement demonstrate compliance with applicable Code requirements.
- Maximum Loan Amount Limit Requirement, which generally limits the maximum loan amount to Participants to the amount specified in the Code. The snapshot also noted that the CARES Act allowed changes to the loan limit for certain loans to “qualified persons”.
- The repayment period requirement, which typically requires that the repayment period of a loan be limited to five years, unless the loan is to purchase the participant’s primary residence. The snapshot also noted that the CARES Act allowed extensions to the repayment period of certain loans to qualified individuals.
- Level payment amounts and quarterly payment requirement, which typically require substantially level amortization over the life of a loan, with payments at least quarterly. The snapshot also indicated that a deemed distribution will occur if a participant fails to make installment payments when due. Where a member fails to make an installment payment, the plan may provide for a period of adjustment that cannot extend beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.
The IRS’s publication of this snapshot reinforces what benefit practitioners know well – plan loan mistakes are not uncommon. In order to reduce the risk of plan loan errors, plan sponsors should consider checking their plan’s transactions for plan loans at least once a year. This audit should include a review of (i) the loan application process (including advice provided to participants regarding loan repayments), (ii) how loan information is transferred to the payroll or supplier and what procedures are in place to ensure that the correct deduction is entered (especially if it is a manual process), (iii) the process to ensure that the amortization period does not extend no more than five years from the original date of the loan, and (iv) the third party administrator’s procedures for loans in default when an employee terminates.
Employers should also consider which groups of employees use the loans most frequently and consider design changes that may reduce the risk of deemed distributions. For example, if the employer’s workforce has frequent turnover, the employer may also consider allowing participants to repay loans through ACH (instead of payroll deductions) so that payments can continue afterwards. termination to help reduce the number of deemed distributions that occur when employees terminate their employment. An ACH reimbursement process has both advantages and disadvantages, and employers should consult a lawyer and their third-party administrators before implementing ACH as a reimbursement method.
By designing the plan’s loan program wisely and performing regular audits of its operations, plan sponsors can reduce the risk of costly compliance errors and help avoid the negative impact that suspected distributions can have on the plan. pension saving.
The snapshot is available here.