Retirement Plan Loans Become High Audit Risk

Posted By Jay Kaufman || 10-Nov-2012

Participants are allowed to borrow from their account balance in some profit sharing and 401(k) plans, if the governing plan document allows. It is optional with the employer.

We have discouraged our employer-clients from including loan provisions in their plan documents because loans have often burdensome administration requirements. There are strict limits. When a participant misses a payment and correction procedures are not timely implemented, the entire plan could potentially be disqualified. Disqualification is disastrous for the employer and all participants.

As a result of the recent economic times, participants with loans have often asked for additional or increased loans. The rules for multiple loans are extremely complex. They are difficult to administer and often impossible to enforce. When payments are not made, the loan is “defaulted”. As a result, the participant has to pay tax on the unpaid amount. Yet, the loan balance continues in his or her plan account.

Form 5500 (or 5500SF, the annual disclosure document filed with the U.S. Department of Labor and the IRS) requires that each employer report whether or not the plan has loans. The IRS has used this information to develop a project to audit a sample of typically small plans with participant loans to determine compliance. As one would expect, the sample error rate was over 90%! The IRS recently announced that it was going to broaden this audit project.

Our advice now is twofold. First, if your plan has loans, be certain that they are constantly in compliance. If you need help from us, please ask. Second, if your plan does not have loan provisions, leave it that way. Resist the temptation to add loans to accommodate participants. The risk far outweighs the reward.

If you get notice of audit from the IRS, do not panic. Send it to us immediately. We’re experienced in IRS audits of tax-qualified retirement plans and are here to support you.

We would like to take this opportunity to remind you of our upcoming post election webinars!

ADVISOR WEBINARS: November 14 at 11AM and November 27 at 1PM
https://attendee.gotowebinar.com/rt/467314778250802688

CLIENT WEBINARS November 27 at 7PM and November 29 at 12:30PM
https://attendee.gotowebinar.com/rt/7607516900753870080

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