Three Loan Errors that Might Be Occurring in Your Retirement Plan Right Now
Loans are among the most complex transactions to administer for defined contribution retirement plan recordkeepers and plan sponsors, second only to the bizarre 15-year catch-up election for 403(b) plans, which, as readers of this blog know, I hate.
Now I don’t hate loans, but retirement plan sponsors who permit loans in their plan need to scrutinize their recordkeeper’s procedures, as well as the data for each loan, to make certain that administrative errors do not occur. In our reviews of retirement plans, we routinely discover many errors relating to loans; these three are among the most common:
- Failing to administer the proper payment frequency — Yes, believe it or not, this seemingly simple task has been screwed up by many a recordkeeper. To be fair to recordkeepers, this is mostly due to the fact that each participant loan has its own unique amortization schedule based on the loan initiation date (as required by the IRS), loan amount and loan term. Most of the errors I have seen involve a loan amortization that was -bi-weekly (26 payments per year), yet the payments are made semi-monthly (24 payments per year). On multiple occasions, I have also witnessed a monthly repayment deducted twice in one month, making the loan repayment twice as large as it should be, or loan repayment amounts that do not match the amount on the amortization schedule in the loan agreement! The problems appear to be particularly rampant when a loan is transferred from one recordkeeper to another.
- Failure to administer the maximum loan limit correctly — Though the dollar maximum itself is indeed complicated to administer (it requires a special calculation relating to outstanding loan balances over the year prior to loan initiation), I actually find that most recordkeepers administer this provision correctly. The problem arises for plan sponsors who maintain multiple plans, or have retirement plan assets (active or inactive) with multiple recordkeepers, as the data is supposed to be aggregated among all plans/recordkeepers in order to calculate the proper loan limits. However, in practice, I have found this aggregation of data to be, let’s just say, sub-optimal.
- Failure to administer loan repayments properly during and after an employee’s unpaid leave of absence — The common errors here are associated with non-military leaves of absence, as military leaves of absence essentially extend the repayment period for the loan by the length of absence, which is what the participant would expect. However, for non-military leaves of absence, the original loan term is not extended, so the participant must either increase their monthly payments to make up for the time that was spent not making repayments or pay a lump sum at the end of the original loan term to make up for the missed repayments. In addition, the leave of absence, for purposes of loan repayment, cannot exceed one year. Leave of absence errors are often exacerbated in plans with payroll deduction for loans, where the payroll system programming needs to be customized for each unique situation in order to properly administer this provision.
It is prudent for plan sponsors to take an opportunity to review your plan for these, and other, possible loan administrative errors. You may be surprised at what you find!
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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