Advanced Issues With Participant Loans, Hardship Withdrawals...

Advanced Issues With Participant Loans,

Hardship Withdrawals and QDROS

Presented by:

Robert M. Kaplan, CPC, QPA, CFP, APA

VP, National Training Consultant

Voya Financial

Agenda

• Hardship Distributions

• QDROs

• Participant Loans

• Questions

Hardship Distributions

• Optional under terms of plan document

• Plan may use “facts and circumstances”

or “safe harbor” reasons

• Must be immediate and heavy financial

need

• 401(k) regulations - §1.401(k) – 1(d)(3)

Polling Question #1

• Hardship distributions are not a

protected benefit and may be amended

out of a plan. Clients may want to

consider this during their current

restatement. Have you ever had a client

eliminate the hardship provision?

– Yes

– No

Hardship Distributions

• Amount may not exceed

amount needed to

satisfy hardship

– But may be trued up for

taxes and penalties

Hardship Distributions

• Safe Harbor definitions:

– Medical care deductible under Tax Code §213(d)

– Purchase of principal residence (excluding

mortgage payments)

– Post-secondary education (next 12 months)

– Prevent eviction or foreclosure from principal

residence

– Funeral expenses

– Casualty deduction home repairs

Hardship Distributions

• Principal residence

– IRS has opined:• Purchase of residence for family members but

NOT the employee would not be allowed

• Purchase of house from an ex-spouse would be

allowed

• These opinions were expressed at industry

functions and are not part of the regulations

Hardship Distributions

• Beneficiaries who incur hardship

may qualify

– Must be primary beneficiary

– Must be at time that the hardship

occurred (cannot change beneficiary

designation after the hardship)

– Applies to medical, education,

funeral expenses

Polling Question #2

• How often do you communicate to

clients that participant beneficiary

forms should be updated?– Never – not my job

– Only after we have a complicated situation

– Annually

– When documents are restated

Hardship Distributions

• Suspension of deferrals may apply– Plans that use “safe harbor”

– Must be six months for safe harbor match plans

– May be up to 12 months for other plans• Always see the plan document for verification

– Plans that use “facts and circumstances” do not have to require a suspension

• Note: Proposed Bill – “SEAL Act” would eliminate the suspension

Hardship Distributions

– Proof of hardship

• Not defined in regulations

• 2008 ASPPA Annual conference IRS stated

that Plan Administrator must have

“sufficient information to adjudicate a

claim – see regulations relating to Katrina”

• My advice – paperwork now can save a lot

of hassle after the fact if an audit or

questions occur

• See next slide for retention guidance

Hardship Distributions

– Retention of Records• IRS Bulletin 2015-4 reminded sponsors that they were

responsible for the records pertaining to loans and

hardships

• Relying on the participant or TPA in not in accordance

with IRS rules

• Beware of self-certification for the reason that the

hardship is being taken (not whether there are other

assets available)

Hardship Distributions

– Does an immediate and

heavy financial need

exist?

• For this part of the

process a plan

administrator may rely

on the representations

of the employee (and

not demand proof)

–Unless “knowledge to the

contrary”

Hardship Distributions

– Rules require that all

other distributions and

nontaxable loans from

all plans of same

employer be taken first

• This does not mean that

all plans must have a

loan provision

Hardship Distributions

– Loan does not have to be taken

if it will be “counterproductive”

• If it will increase hardship such as

preventing a third-party loan

(mortgage for primary residence)

or take home pay would be

lowered too much

• There is no criteria in regulations

for this

–Documentation should be kept

Hardship Distributions –

What to Do?????

� Participant is five months behind in mortgage payments

� Receives letter threatening foreclosure� Needs $5,000 for late payments, legal

fees and bank fees associated with foreclosure

� Real estate taxes of $1,800 are due next month

� Can’t make next two payments totaling $1,200

� Question: Can he take one hardship instead of three (to save on distribution expenses)

Hardship Distributions

� Plan Administrator needs to consider:� The 12 month in advance rule that applies to tuition

does not apply to other hardship reasons

� No specific IRS guidance on this matter

� If you allow two months –where is the line drawn, at

three, four, twelve?

� Need to look at the immediate and heavy financial

need. If Plan Administrator is comfortable that

documentation will be sufficient in an audit situation

� Bob’s caution – if the foreclosure has not been

threatened because of the taxes and future

payments the criteria may not be satisfied. How

threatening is the letter about future payments?

QDROs

� Brown vs. Continental Air Lines

� 5th Circuit Court of Appeals

� Sham divorces

� What is the responsibility of the Plan

Administrator in determining

whether a divorce is valid or not?

QDROs

� Continental DB Plan

� Fear that company would go bankrupt and PBGC assumes responsibility for payouts

� Payouts for high income personnel could be slashed

� Cannot just “take money now” as no distributable event exists

� So what do to….????

QDROs

� D-I-V-O-R-C-E (not the Tammy Wynette song)

� Get a quick divorce and assign QDRO to alternate payees (90 to 100% of benefit)

� This creates a distributable event when one otherwise did not exist

� Note: Participants soon remarried and it appears they were living together “as a married couple” all along

QDROs

� Continental saw this as a sham divorce just to get money out of plan

� Court said that the Plan Administrator went beyond its authority� Merely has to determine on the surface if the order meets ERISA

rules

� It does not require or permit a plan to look further

� Participants win

� The court did not rule on whether a Plan Administrator could retroactively revoke a QDRO

QDROs

� ERISA Advisory Opinion 99-13A

� Plan has the obligation to review the DRO for

reasonableness

� Could (or should) have warned the state agency of

the validness of it

� But not take action itself

Loans - Some Statistics

• 88% of plans allow for participant loans

• Coincidently, 88% of plans allow for hardship withdrawals (but not all the same plans)

• 24% of all 401(k) plan participants have at least one outstanding loan

Bankruptcy

• If a participant declares

personal bankruptcy –

do the participant loan

repayments continue?

Bankruptcy

• If a participant declares

personal bankruptcy – do

the participant loan

repayments continue?

• “Yes”

– The Bankruptcy Abuse

Prevention and Consumer

Protection Act of 2005

Bankruptcy

• Can I take a participant

loan, place it all in a bank

account, declare

bankruptcy and have it

protected?

Bankruptcy

• Can I take a participant

loan, place it all in a bank

account, declare

bankruptcy and have it

protected?

• “No” – per California court

case Friedman vs. Broach

Bankruptcy• What if the participant

wants to stop repaying loan

(they understand tax

consequences) – can they

ask to have salary reduction

repayments stopped?

Bankruptcy• What if the participant, who

declares bankruptcy, wants

to stop repaying loan (they

understand tax

consequences) – can they

ask to have salary reduction

repayments stopped?

• “No” – Section 523(a)(18) of

2005 Bankruptcy law does

not discharge the obligation

of a participant to a

retirement plan

Depositing Repayments• Salary reduction

repayments must be made

“as soon as administratively

feasible”

• Small plans (under 100

lives) may rely on the

proposed regulations for

elective deferrals that have

a 7 business day safe harbor

Leave of Absence

• Suspensions

– Plan may allow a suspension of

repayments for up to 12 months as long

as it does not go beyond original 5 year

period

• Approved leave (maternity for example)

–Strikes do not count as approved leave

• Layoff

• Note: interest still accrues

Leave of Absence - USERRA

• Suspensions

– USERRA – may extend beyond

5 year period for the time on

active duty

– Interest still accrues

– Interest rate may be capped

at 6% during military duty if

requested by participant

Deemed Distributions

• Cure period for missed payments –

last day of the calendar quarter

following the missed payment

Payment due – May 14, 2015

Cure period ends September 30, 2015

• Plan could default payment sooner –

see Loan Policy

Deemed Distributions

• Deemed distribution for tax purposes

= Principal and Interest until the

default date

– Therefore total taxable amount is more

than just the total of the missed

payments

• 10% penalty under 59 ½

Deemed Distributions

• Most plans use payroll withholding to

simplify the procedures and ensure

that the payments will be made

timely

• If the payroll department fails to set

up the withholding – it can still be a

problem for participant (Leonard vs.

IRS)

– There is an EPCRS correction

Deemed Distributions

• Defaulted Loans

• Don’t accrue interest, except

– To calculate loan maximums for

additional loan

– To repay with after-tax dollars

– Yes, loans are still due and payable even

after a taxable event

Deemed Distributions - Roth

• Roth defaults will never be

considered a “qualified distribution”

thus the earnings will be taxable and

subject to a 10% penalty, if applicable

Polling Question #3

• When do you start the 5 year clock

running on participant loans?

– The date the loan is requested

– The date the loan is distributed

– The date the first payment is due

– Whoops – I thought someone else would

do it

Offsets

• Loan is offset from

the participant

account only at the

time that a

participant has a

distributable event

Default or Offset

• Same participant

who defaulted takes

another participant

loan

– Require payroll

withholding, or

– Require additional

collateral

Refinancing

• Only if allowed by plan

• Reasons

– Interest rate

– Frequency of payments

– Extend loan to statutory

allowable (three year loan

extended to full five years)

– Additional funds

Refinancing

• Replacement loan is

treated as a new loan for

– Re-determine interest

rate and maximum limits

Refinancing• If new loan

repayments extend

beyond original 5

year payment period

then both the new

and old loans will

need to be taken into

account for the

maximum loan

amounts

Refinancing – Example I

• Old Loan = $11,000

• New Loan = $18,000

– Repay old loan and receive additional

$7,000

– New loan payable over a 5 year period re-

starting now

• Total loans = $11,000 + $18,000 =

$29,000

Refinancing – Example II

• Old Loan = $11,000

• New Loan = $18,000

– Repay old loan and receive additional

$7,000

– New loan will be repaid within the

original 5 year period of the Old Loan

• Total loans = $18,000

– You do not have to combine the two

limits

Refinancing – Example III

• Old Loan = $11,000

• New Loan = $18,000

– Repay old loan and receive additional $7,000

– New loan will be not repaid within the original 5

year period of the Old Loan

– Same result as taking a separate loan

• However, repayments will reflect $18,000

amortization until old loan 5 year period is up

and based on $7,000 loan until new 5 year

period is up

– Result is same as taking a new $7,000 loan but it

is accomplished in one loan and not two

Procedural Issues

• Spousal Consent – required when

plan is subject J & S rules– DOMA

• QDRO – loan is not assigned to

alternate payee – it remains in

entirety to the participant– DOMA

Procedural Issues

• Rollovers of Loans

• Allowed if:

– Distributing plan allows and in-kind

distribution

– Receiving plan allows loans

– Receiving plan allows rollovers

– Receiving plan allows rollovers of loans

– Note: Loans may not be rolled to IRAs

(including SIMPLE or SEP IRAs)

Procedural Issues

• Common to have Mergers and

Acquisitions that affect plans

• How are your clients handling

when there are outstanding loans

– Are they allowing rollovers into

surviving plan

Redemption• EPCRS (Rev. Proc. 2013-12)

allows for correction of loan

operational errors

– More than maximum

– Longer than 5 years

– Defaults

– Not in plan document

Questions

• !

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