PLANSPONSOR - October/November 2018 - 56

Administrative Errors
Andrew Zito, executive vice president, LAMCO Advisory Services
in Orlando, Florida, chronicles the typical loan process: The
employee goes to the website of his employer's retirement plan
and requests a loan from his account. The payment amount is fed
through a system to the employer, and the employer sets the loan
up in its payroll system so deductions occur. The employer then
remits the payment with the payroll and deferral files.
Loans can be complicated to administer and carry a risk of
default through administrative error, Zaklad notes. For example,
she says, a payment gets missed through no fault of the participant,
but most often due to a payroll
glitch; then several more get missed. The
participant is not notified, payments are
not made, and the loan is in default with
participant tax implications.
" Most often what we see is a failure in
the piece where it moves from the recordkeeper's
system to the payroll system
and then the payment being processed
through payroll on time, " Zito agrees.
The administrative errors can be
would be over the plan limit.
A common error, Zaklad says, is a participant taking two loans
when just one is allowed. " It's possible that a loan is completed
online and the system allows it. Or it could just be a snafu that a
participant has an outstanding loan and he is granted another. "
WITH A
REFINANCING
POLICY, IF A PERSON
complex. Zito cites another instance
he observed: A plan sponsor changed
its policy to allow multiple loans, but
the payroll system allowed for only one
loan deduction. A participant then took
a second loan, but the payroll system
was not set up to deduct more than one.
The plan sponsor contacted the payroll
provider to create areas for additional
loans, but meanwhile any second loans were not getting repaid
and eventually were subject to default. " In some cases, I've seen
loans go six months before being entered into payroll, " he says.
Zito suggests that if participants discover that no deductions
Special Case Considerations
Other quirky issues, Zito, says, illustrate the administrative challenges
of loans. Problems often arise with restaurant workers
or with employees who work on commission and do not receive
regular paychecks; they often go through periods where their
checks are small or zero. " These participants
should technically still make a loan
payment, but if there is no check to take
it from, then payroll must take two loan
payments from the next check, " he says.
Another such example involves
HAS ONE OUTSTANDING
LOAN, HE CAN
ADD ON ADDITIONAL
MONEY AS LONG
AS HE STAYS WITHIN
THE STATUTORY
LIMIT ... "
are being taken from their paycheck, they should notify their
employer. But they rarely do, he says. In cases where the payments
are not made due to an error by the employer, there are ways to
correct the problem and avoid having the loan default and be
treated like a distribution. Depending on the amount of time the
loan went unpaid, there are a few possible methods. Most common
is the IRS's Voluntary Fiduciary Corrections Program (VFCP). If a
reversal is possible, the plan can avoid the 1099 situation, wherein
the amount is taxed as a distribution. The VFCP is designed to
encourage employers to voluntarily comply with the Employee
Retirement Income Security Act (ERISA) by self-correcting
certain violations of the law.
Jinnie Olson, plan manager, operations, for Milliman in
Minneapolis, cites a similar operational problem: failing to count
a defaulted loan as outstanding. This means if a plan allows only
one loan, which a participant takes and defaults on, it remains
active-he may not take another. An operational failure would
be to allow the participant to take a new loan, which technically
56 PLANSPONSOR.com October-November 2018
mergers and acquisitions, which can
create havoc with loans, sources say. In
the case of a merger, there is often an A
plan and a B plan. If the B plan is terminated
and participants get moved into
the A, the B plan's borrowers can no
longer make payments to their old plan.
So these loans go into default and are
deemed distributable through no fault of
the participants' own. Those rehired by
the new company must repay their loan
immediately or take it as a distribution.
Olson mentions another type of
common error that arises with loans.
Plan provisions allow loan payments to be suspended when an
employee goes on leave. Each leave is a unique situation; therefore,
it is difficult to follow a set process. But if the plan sponsor
neglects to report the leave to payroll, Olson says, the loan will go
into default. Or maybe a participant loan does get suspended as it
should but not reactivated when the leave ends. The loan will need
to be re-amortized over the life of the loan to allow the borrower
to make a balloon payment to compensate for payments missed
while he was out.
" As long as a loan has not defaulted, most loan issues can
be worked out internally between the participant, recordkeeper
and plan sponsor, " Olson says. " If the participant has gone into
default, it requires an IRS Voluntary Correction Program filing
to fix the loan, which is more complicated and involves fees. "
Prevention Using Checks and Balances
How can plan sponsors guard against administrative errors,
which could send a participant loan into default? Importantly,
sources agree that sponsors need to be diligent about having a
process in place to check loans' status-and to double-check it.
Olson says, besides the recording and monitoring that goes
into a loan provision, there is a joint responsibility between the
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PLANSPONSOR - October/November 2018

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