Participant Loans from Qualified Retirement Plans

1. Presented By Adam C. Pozek, ERPA, QPA, QPFC Partner DWC ERISA Consultants, LLC Participant Loans DWC University – Workshop 4

2. Usage  According to PSCA 51st Annual Survey (2007) ◉ Plans   ◉ 86.3% of 401(k) plans 41.9% of profit sharing plans Participants   23.6% with outstanding balances Average balance of $7,655  Wall Street Journal (June 2011) ◉ Double-digit increases in loans since 2009 ◉ More than 30% with loans Slide | 2

3. A Brief Regulatory History  1982: Regulations published  1986: Regulations revised  1995: Regulations proposed  1998: Regulations re-proposed  2000: Regulations re-proposed  2000: Regulations finalized (effective in 2000)  2002: Regulations re-finalized (effective in 2004) Slide | 3

4. Overview  ERISA and IRC prohibits loans to parties in interest, including participants ◉ ◉ ERISA §406(a)(1)(B) IRC §4975(c)(1)(B)  Internal Revenue Code prohibits use of plan assets as security for a loan ◉ IRC §401(a)(13)  Both provide exceptions if certain requirements are met ◉ ◉ ◉ IRC §72(p) IRC §4975(d)(1) ERISA §408(b)(1) and DOL Reg. §2550.408b-1 Slide | 4

5. Overview All loans from plans to participants start out wrong and must be made right. Slide | 5

6. Part 1 T HE R EQUIREMENTS

7. What Are The Requirements?  Provision in plan document  Written loan program  Enforceable agreement  Availability on a reasonably equivalent basis  Reasonable rate of interest  Limited term  Limited amount  Timely payments Slide | 7

8. Written Loan Program  Must include all terms by which loans are granted and administered, including: ◉ ◉ ◉ ◉ Interest rate Maximum amounts Repayment terms See DOL Reg. §2550.408b-1(d)  If provisions not in SPD, loan program must be provided to participants  Prospective updates permitted  Provisions may be incorporated into plan document ◉ Requires formal amendment to change Slide | 8

9. Written Loan Program Failure to have, distribute or follow loan program makes all loans prohibited transactions. Slide | 9

10. Enforceable Agreement  Loan agreements must be… ◉ Enforceable under state law  ◉ Statute of Frauds In the prescribed format  Loan agreements must include… ◉ All terms of the loan ◉ Promissory note ◉ Irrevocable pledge ◉ Truth-in-lending disclosure repealed  Unenforceable agreement = prohibited transaction Slide | 10

11. Availability  On a reasonably equivalent basis ◉ HCEs and NHCEs  May not be restricted based on religion, gender, etc.  Need not be available to some terminated participants ◉ ◉ DOL Advisory Opinion 89-30A Treas. Reg. §1.401(a)(4)-10(c)  May not have a minimum of more than $1,000  May consider normal commercial factors such as credit-worthiness, etc. Slide | 11

12. Interest Rate  Similar to a rate a commercial lending institution would charge on a similar loan ◉ Fully secured  DOL has rejected prime-based rate as safe harbor  Commercial lending institutions often use prime- based rates  See DOL Reg. §2550.408b-1(e) Slide | 12

13. Term of Loan  Must be amortized in level installments ◉ At least quarterly ◉ Usually based on payroll  Cannot be amortized for more than 5 years ◉ Primary residence exception  Q&A from Annual Conference Slide | 13

14. Amount of Loan  Minimum may be set from $0 to $1,000  Maximum limited by statute to the lesser of… ◉ 50% of participant’s vested account balance, or ◉ $50,000 less the highest outstanding loan balance during the immediately preceding 12-month period  Exception for loans up to $10,000 rarely used ◉ Outside collateral  Plan may set lower maximum Slide | 14

15. Example #1  Limits ◉ Minimum = $1,000 ◉ Maximum = statutory Balance Vested % Vested Balance Elective Deferrals $1,500 100% $1,500 Employer Match $1,000 20% $ 200 Total $2,500 50% of Vested Balance $1,700 $ 850  No loan permitted ◉ $850 < $1,000 minimum Slide | 15

16. Example #2  Limits ◉ Minimum = $1,000 ◉ Maximum = statutory Balance Vested % Vested Balance Elective Deferrals $85,000 100% $85,000 Employer Match $50,000 100% $50,000 Total $135,000 50% of Vested Balance $135,000 $67,500  Maximum loan = $50,000 Slide | 16

17. Example #3  Limits ◉ Minimum = $1,000 ◉ Maximum = statutory  Participant paid off $15,000 loan eleven months ago Balance Vested % Vested Balance Elective Deferrals $85,000 100% $85,000 Employer Match $50,000 100% $50,000 Total 50% of Vested Balance $135,000 $135,000 $67,500  Maximum loan = $35,000 ◉ $50k (max) less $15k (highest o/s balance in last 12 months) Slide | 17

18. Part 2 T HE O PTIONS

19. What Are The Options?  Reasons  Frequency  Number  Sources ◉ Calculation of availability ◉ Proceeds  Method of payment  Termination of employment  Refinancing  Rollovers in Slide | 19

20. Reasons For Loans  Any reason ◉ Assumed if loan policy is silent  Financial hardship ◉ Tied to regulatory definition of hardship ◉ Nondiscriminatory standard set/approved by sponsor  Other ◉ Must be nondiscriminatory Slide | 20

21. Frequency/Number Of Loans  Number ◉ One at a time ◉ One throughout entire duration of plan participation ◉ One for hardship and one general purpose ◉ Multiple loans at the same time  Frequency ◉ One in any 12-month period ◉ Subsequent loan immediately on repayment of prior loan ◉ Subsequent loan 90 days following repayment of prior loan  Must be documented in loan policy ◉ Silence = no limitation Slide | 21

22. Sources  Determination of loan availability ◉ All sources ◉ Fully vested sources only  Proceeds for funding loan ◉ Same general options ◉ May further limit loan availability  Must be documented in loan policy ◉ Silence = no limitation Slide | 22

23. Example #4  Limits ◉ Minimum = $1,000 ◉ Maximum = statutory ◉ Source limitations   All accounts for availability Proceeds from elective deferrals Balance Vested % Vested Balance Elective Deferrals $2,000 100% $2,000 Employer Match $1,000 80% $800 Profit Sharing $10,000 80% $8,000 Total $13,000 50% of Vested Balance $10,800 $5,400  Maximum loan = $2,000 Slide | 23

24. Methods Of Payment  After-tax payroll deduction ◉ Most common  Personal check ◉ Responsibility for collecting bounced checks ◉ Issues with fees for rejected checks  Cashiers check or money order  Combination ◉ Payroll deduction for regular payments and cashiers check for full repayment  Review plan loan policy and individual loan paperwork Slide | 24

25. Early Payment  Only if paid in full ◉ Recommended  Partial pre-payment ◉ Apply first to cover any interest due ◉ Remaining amount all to principal ◉ Future payments continue at same amount until full repayment ◉ Requires adjustment to future breakdown of principal and interest ◉ Limitations of recordkeeping system ◉ Adjustments to payroll Slide | 25

26. Termination of Employment  Immediate default/deemed distribution ◉ More to come on this  Lump sum repayment within set time limit  Continuing payments ◉ Personal check, money order, etc.  Review loan policy and loan paperwork Slide | 26

27. Refinancing…Ugh  Addressed in final final regulations effective January 1, 2004 ◉ Treas. Reg. §1.72(p)-1, Q&A-20  Rules apply to any renegotiation of loan terms  Two general options ◉ Without extension of original loan maturity date ◉ With extension of original loan maturity date  Should be addressed in loan policy  Silence ≠ no limitation  Very messy and difficult to do correctly Slide | 27

28. Refinancing Without Extension  Does not change any of the terms applicable to original loan amount  Looks like multiple loans or variable payment loan  Maximizes the additional amounts available Slide | 28

29. Example #5  Loan #1 ◉ Taken April 3, 2006 ◉ Principal amount = $50,000 ◉ Amortized for 5 years  ◉ Full repayment by March 31, 2011 Monthly payment = $961.78 Slide | 29

30. Example #5 (cont’d)  Refinance #1 ◉ Taken January 20, 2009 ◉ Initial loan   ◉ Current balance = $24,945.85 Highest balance in last 12 months = $34,715.10 Amortized for 5 years  Full repayment by December 31, 2014 Amount Available $ 50,000.00 Less Highest O/S Balance -$ 34,715.10 Additional Loan Proceeds Taken Total O/S Balance ◉ $ 15,284.90 $ 40,230.75 Additional monthly payment = $275.86 Slide | 30

31. Example #5 (cont’d)  Refinance #2 ◉ Taken September 7, 2010 ◉ Initial loan   ◉ Current balance = $17,104.22 Highest balance in last 12 months = $31,151.50 Amortized for 5 years  Full repayment by August 31, 2015 Amount Available $ 50,000.00 Less Highest O/S Balance Additional Loan Proceeds Taken $ 18,848.50 Total O/S Balance ◉ -$ 31,151.50 $ 35,952.72 Additional monthly payment = $340.55 Slide | 31

32. Example #5 (cont’d) April 30, 2011 to December 31, 2014 January 31, 2015 to August 31, 2015 April 30, 2006 to December 31, 2008 Loan #1 April 3, 2006 $50,000 January 31, 2009 to August 31, 2010 September 30, 2010 to March 31, 2011 Monthly Payment = $961.78 Monthly Payment = $961.78 Monthly Payment = $961.78 Monthly Payment = $275.86 Monthly Payment = $275.86 Monthly Payment = $275.86 Monthly Payment = $340.55 Monthly Payment = $340.55 Monthly Payment = $340.55 Total Monthly Payment = $1,578.19 Total Monthly Payment = $616.41 Total Monthly Payment = $340.55 Refinance #1 January 20, 2009 $15,284.90 Refinance #2 September 7, 2010 $18,848.50 Total Monthly Payment = $961.78 Total Monthly Payment = $1,237.64 Slide | 32

33. Refinancing With Extension  Allows for extension of original loan maturity  Allows for renegotiation of existing loan terms  Limits additional loan availability by requiring current outstanding balance to be counted twice Slide | 33

34. Example #6  Initial loan ◉ Taken January 1, 2004 ◉ Principal amount = $10,000 ◉ Amortized for 5 years  ◉ Full repayment by December 31, 2008 Monthly payment = $250 Slide | 34

35. Example #6 (cont’d)  Refinance ◉ Taken January 1, 2007 ◉ Initial loan   ◉ Current balance = $4,000 Additional request = $5,500 Requested amortization for additional 5 years  Full repayment by December 31, 2011 Amount Available Amount of New Loan $ 9,500 Outstanding Loan Balance $ 4,000 Total Loan Amount $ 13,500 Vested Balance Needed $27,000 Slide | 35

36. Accepting Rollovers Of Loans  Must be permitted by plan document and/or loan policy  Consider provisions of other plan ◉ Immediate default on termination of employment  Consider timing issues ◉ From final payroll at prior employer to first payroll at new employer ◉ Differences in payroll schedules  Change in schedule is a renegotiation subject to refinance rules Slide | 36

37. Part 3 D EFAULTS , D EEMED D ISTRIBUTIONS A ND O FFSETS

38. Loan Defaults  As soon as regularly scheduled payment is missed  No exception for payroll errors  Cure period ◉ End of the quarter following the quarter of default  ◉ ◉ Ends on the last day of that quarter, not first day of next quarter Loan policy may provide for shorter cure period All payments plus accrued interest brought up to date Slide | 38

39. Deemed Distribution  Amounts exceeding limits, restrictions, etc. ◉ Over dollar limit ◉ Outstanding balance at the end of the 5-year period ◉ Outstanding balance plus accrued interest at end of cure period  Treated as distribution from plan ◉ Subject to ordinary income tax ◉ Early withdrawal penalty (10%) applies if under age 59 ½ ◉ Mandatory withholding (20%) if in conjunction with cash distribution  ◉ Calculated on total amount of cash + loan Form 1099-R issued in January of following year Slide | 39

40. Deemed Distribution  Does not extinguish obligation to repay loan ◉ Payments continue pursuant to loan terms ◉ Creates after-tax basis in the plan ◉ Requires separate accounting on recordkeeping system for proper tax reporting in the future Slide | 40

41. Examples of Deemed Distribution  Loan taken for $54,000 ◉ Deemed distribution = $4,000  Loan taken for $6,000 when 50% of vested balance is only $5,800 ◉ Deemed distribution = $200  Balance at end of 5 years is $100 due to payroll error ◉ Deemed distribution = $100 Slide | 41

42. Examples of Deemed Distribution  Loan taken for $10,000 but paperwork not signed ◉ Deemed distribution = $10,000  Loan taken for $50,000 but plan doesn’t permit loans ◉ Deemed distribution = $50,000  Loan taken for $25,000 over 70 months ◉ Deemed distribution = $25,000 ◉ See Treas. Reg. §1.72(p)-1, A-4 Slide | 42

43. Offset  Deemed distributed loan remains on plan financial statements until offset ◉ ◉ Requires distributable event Concurrent with deemed distribution due to termination of employment  Phantom interest continues to accrue until offset Slide | 43

44. Correction of Loan Failures  Permitted under Employee Plans Compliance Resolution System ◉ IRS Revenue Procedure 2008-50  Requires actual submission to IRS using VCP ◉ Loans under joint IRS/DOL jurisdiction ◉ Although IRS recognizes self-correction, DOL does not ◉ VCP fee discounted by 50% if fewer than 25% affected  More to come in a future session on plan corrections Slide | 44

45. Part 4 M ISCELLANEOUS

46. Discontinuance of Payments  Employer cannot honor request by active participant to stop withholding payments ◉ ◉ Violation of loan policy and loan itself Fiduciary obligation to enforce loan policy, including collection of payments  ◉ Fiduciary obligation to collect amounts owed to the plan  ◉ ◉ McLaughlin v. Rowley, 698 F. Supp. 1333 (N.D. Tex. 1988) DOL Field Assistance Bulletin 2008-01 Fiduciary breach to permit devaluation of plan asset ERISA pre-emption of state withholding laws Slide | 46

47. Leaves of Absence  Suspension of payments for up to one year if ◉ Leave without pay, or ◉ Leave pay < loan payment  Continued accrual of interest  Repayments following suspension ◉ Must resume at end of leave or at end of 12 month suspension ◉ No extension of 5-year amortization rule  See Treas. Reg. §1.72(p)-1, Q&A-9 Slide | 47

48. Special Rule For Military Leave  Suspension may extend beyond 1 year ◉ IRC §414(u) as added by USERRA (1994)  Interest accruals ◉ Continued accrual during leave, but ◉ Rate cannot exceed 6%   Servicemembers Civil Relief Act of 2003 Soldiers and Sailors Civil Relief Act of 1940  Repayments following military leave ◉ Must resume when leave ends ◉ Maximum repayment period extended by length of leave Slide | 48

49. For Further Reading  ERISA Outline Book ◉ Chapter 7  Section IX  “Rollovers of Loans from an Acquired Company’s 401(k) Plan” ◉ Journal of Pension Benefits, Autumn 2011 Slide | 49

50. Questions Page | 50 Adam C. Pozek, ERPA, QPA, QPFC Partner DWC ERISA Consultants, LLC 651.204.2600 ext. 107 www.linkedin.com/in/adampozek Adam.Pozek@DWCConsultants.com Twitter.com/PozekOnPension www.DWCConsultants.com www.PozekOnPension.com DWCAdamPozek AdamCPozek

51. Caveats & Disclaimers THE CONTENT OF THIS PRESENTATION GENERAL IN NATURE AND IS FOR INFORMATIONAL PURPOSES ONLY. IT SHOULD NOT BE USED AS A SUBSTITUTE FOR SPECIFIC TAX, LEGAL AND/OR FINANCIAL ADVICE THAT CONSIDERS ALL RELEVANT FACTS AND CIRCUMSTANCES. TO ENSURE COMPLIANCE WITH THE REQUIREMENTS IMPOSED ON US BY IRS CIRCULAR 230, WE INFORM YOU THAT ANY TAX ADVICE CONTAINED IN THIS COMMUNICATION (INCLUDING ANY ATTACHMENTS) IS NOT INTENDED AND CANNOT BE USED FOR THE PURPOSE OF: (I) AVOIDING TAX-RELATED PENALTIES UNDER THE INTERNAL REVENUE CODE, OR (II) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY TAX-RELATED MATTER(S) ADDRESSED HEREIN.

Participant Loans from Qualified Retirement Plans

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Participant Loans from Qualified Retirement Plans