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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
• !
We’d Like to Thank Our Sponsors of
the 2015 ASPPA Virtual Conference