Although retirement plan loans can increase administrative responsibilities, many plan sponsors include them as a plan feature with the idea that offering participant loans can help to encourage a higher participation rate—increasing the amount of contributions going into the plan while allowing a participant means to access vested money.
A participant loan must satisfy certain rules under the Internal Revenue Code (the “Code”) to prevent the loan from being treated as a taxable distribution to the participant and plan qualification issue. Separately, a participant loan must meet statutory requirements of the Code (with parallel sections found in the Employee Retirement Income Security Act of 1974 (ERISA)) so as not to become a prohibited transaction. It is not unusual for plan sponsors to discover that one or more of these rules have not been followed in administering the plan.
Fortunately, the IRS has some helpful resources that address loan failures impacting the qualification of the plan and tax liability of the individual participant. A number of common loan failures, such as missed repayments or loans exceeding the maximum permissible amount or term, can be corrected under the Employee Plans Compliance Resolution System (EPCRS). A summary of these types of failures and approved correction methods is included in the IRS’s 401(k) Plan Fix-It Guide.
It's important to note that these errors are corrected under the Voluntary Correction Program (VCP) and are not eligible for self-correction. In 2015, the IRS made some modifications to EPCRS, which included a reduction of its VCP filing fees for loan failures. Prior to this revision, the filing fees for these types of failures ranged from $375 to $12,500. The new fees range from $300 to $3,000.
As is mentioned in the IRS guide, not all plan loan errors can be fully corrected under EPCRS (see 9b). In certain circumstances, a particular loan failure may result in a fiduciary violation under ERISA. Plan sponsors should consider the Department of Labor’s Voluntary Fiduciary Correction Program (VFCP) under appropriate circumstances.
Having strong controls and procedures in place are key to preventing these types of errors. For example, reviewing your plan’s loan delinquency report on a regular basis can go a long way in preventing unintended loan defaults. You can access this report under the Reporting tab in Fidelity Plan Sponsor WebStation® (PSW®). Reviewing and updating the plan’s loan interest rate to ensure it remains consistent with the rules established in your plan document, as well as commercial lending rates, is another best practice.
Despite all of your best efforts, mistakes can happen. Knowing that these resources are available to correct the problem can provide valuable relief.
If you have any questions about this topic, please contact your Fidelity representative.