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Plan Loan Mistakes 101

Making it possible for participants to take a loan from their retirement accounts is a common plan feature. But it also is not unusual for mistakes to be made concerning those loans. A recent article, as well as the IRS, offer some suggestions regarding how to identify and fix them, as well as avoid them altogether.

In “How to Find, Fix and Avoid Plan Loan Mistakes,” an article appearing in The Newport Group’s Second Quarter edition of their PlanFacts newsletter, the authors argue that mistakes with plan loans are all but inevitable. “Administering plan loans typically involves multiple people from several organizations, including your human resources staff, your payroll provider, and a third party administrator or recordkeeper. Mistakes are bound to happen,” the write.

Avoiding Plan Loan Mistakes

An ounce of prevention is worth a pound of cure, says the old maxim. Archaic, perhaps, but nonetheless true — avoiding a mistake in the first place is preferable to having to address one. And the IRS in the 403(b) Plan Fix-It Guide warns that relying on a vendor is not sufficient to absolve a plan sponsor or its responsibility. Says the IRS,  “Many 403(b) plan sponsors rely on many vendors to maintain their plan; however, the plan sponsor is always responsible for the plan’s operation, including its loan program. Plan sponsors are responsible for determining that each participant loan meets the requirements of the loan program and for enforcing loan repayments. ‘Hold harmless’ agreements between a 403(b) plan sponsor and its vendors don’t lessen the plan sponsor’s responsibility.”

The IRS says that participant loans must meet a number of rules to prevent the law from treating them as a taxable distribution, and that there are two major areas of concern: (1) whether the written 403(b) plan allows for participant loans and (2) whether those loans meet the requirements of Internal Revenue Code Section 72(p).

Finding Mistakes

The IRS suggests that plan loan mistakes can be found by reviewing the loan agreements and loan repayments to verify they have met the Internal Revenue Code Section 72(p) rules to prevent the loans from being treated as taxable distributions. This review, they say, should include:

  1. the loan requirements outlined in the written program;
  2. each participant loan agreement;
  3. whether each loan was made following the rules of Section 72(p) and the loan payments are being deposited to the plan on time.

Fixing Mistakes

The authors note that the IRS offers a way to fix plan loan mistakes through its Employee Plans Compliance Resolution System (EPCRS), and that now certain mistakes may be corrected through the IRS Self-Correction Program. To do that, they write, an employer must have practices and procedures that are designed to promote overall compliance with applicable IRS rules. They add that if a defaulted loan presents any prohibited transaction concerns, they must be addressed by through the IRS Voluntary Compliance Program.