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
ADVISOR WEBINARS: November 14 at 11AM and November 27 at 1PM
CLIENT WEBINARS November 27 at 7PM and November 29 at 12:30PM