Why Plan Sponsors Should Treat Loans Like Investments | EBA

When the coronavirus outbreak turned into a COVID outbreak followed by lockdowns in many states, Congress stepped in to help by passing the Coronavirus Aid, Relief and Economic Security Act with broad support. . The first provisions of the CARES Act (and now likewise included in the Consolidated Appropriation Act) providing for payments to individuals, as well as those allowing sponsors of 401 (k) workplace pension plans to temporarily increase loan and withdrawal limits have been largely covered over time, but it is the rules that allow qualified people to delay their retirement loan repayments that can have a lasting impact for plan sponsors.

Plan sponsors have always treated loans as an administrative program, outside the confines of fiduciary standards and scrutiny. The Department of Labor (DOL), however, is of the view that a participating loan is an investment in the plan and requires the same fiduciary oversight as any other investment in the plan. And loan administration, an area that most plan sponsors don’t spend much time on, has become more complex.

Take the test
Why worry? The Ministry of Labor auditors seemed friendly enough and were blunt about the information they needed to begin the audit. The retirement manager of a large industrial services company would simply share the request with his record-keeping account manager and pull the information together within days. After all, his employer had hired a large financial services company for a job like this, and they had to go through it a thousand times. The listener may not even need to visit.

However, things didn’t quite work out that way. Several months later, the auditors were still at work; by the time they were done, the retirement director knew a lot more about his loan program. Her employer had to remedy several shortcomings to complete the audit and make a large payment.

What happened? It is best to start at the beginning.

The administration of 401 (k) plans and their assets is primarily governed by the Employees Retirement Income Security Act. But ERISA is written in a way that leaves room for interpretation, leading to many challenges involving plan investments to be resolved through high profile and costly litigation. In what appears to be an acknowledgment of this, DOL is using its own resources to focus more broadly on plan administration and enforcement, where popular features like plan loans can prove to be very difficult.

Ready a mature environment
Loans are a particularly fertile testing ground for several reasons, according to lawyers familiar with the issues. On the one hand, the loans themselves are only permitted as an exemption from the rules governing the use of a plan’s investments, making it an area of ​​natural interest. In fact, the DOL classifies its lending rules as part of a “prohibited transaction exemption”. Exemptions, by law, must be administered with care.

Loan administration can be complex. Both the DOL and the Internal Revenue Service (IRS) adhere to the “form and function” mantra: Not only must the plan documents be written correctly, the plan must function according to those terms. Loan administration can be riddled with errors because loans cut across so many areas, and several important data points usually fall outside the scope of standard archiving services. These areas including verification of employment status, details related to loan default, job classification and compensation directive must be maintained by the plan sponsor himself to establish compliance.

Read more: Views Pandemic highlights the importance of reviewing secure retirement options for employees

There is also the issue of defaults, which is often a specific focus of IRS reviews. A loan is a formal plan investment evidenced by an actual contract between the plan and the borrowing members, and these loans are expected to be repaid or taxed in a timely manner. But defaults can be difficult to document and administer properly, which has been made even worse by rules that now require plan sponsors to separately report “loan offsets” on Form 1099-R. Regulators have the information they need to target their resources.

Approaches for plan sponsors
Most plan sponsors can be confident that their plan administrator is doing all that needs to be done. But it is the plan sponsor, not its administrator, that the IRS and DOL will hold accountable for the proper administration of the loans, and they may well serve the plan sponsor to intensify its own oversight. Although loan approval and administration has been largely outsourced for years, these remain fiduciary responsibilities.

Plan sponsors interested in an objective third-party review of their loan programs may hire consultants or their own auditors to conduct a regulatory-style review. An independent audit can provide plan sponsors with a one-off review. However, these services can be expensive and of limited value if they are not provided on a regular basis.

Another option for plan sponsors is to establish a loan insurance program that pays off all or part of the outstanding loan balance of any worker who loses their job. This program in itself significantly reduces loan risk by automatically reducing the level of defaults, thereby supporting the financial well-being goals that many plan sponsors pursue. And because a loan insurance program organizes a plan’s loan data – including the areas that often lie between a plan sponsor and their third party responsible for the records – it has the added benefit of creating and documenting. the type of improved compliance procedures and loan data that can serve the sponsor well during an audit.

Look ahead
The CARES Act and Consolidated Appropriations Act both leverage 401 (k) plans to free up funds for workers affected by COVID and other federally declared disasters. But once these special arrangements are completed, any loan that falls behind will be subject to default. It’s up to plan sponsors to make sense of all of this.

The additional collateral of loan insurance can help demonstrate to regulators that the plan sponsor has established compliant procedures and regularly assesses its own performance. Loan insurance provides plan trustees – who are responsible for monitoring, evaluating and acting as necessary – with a means to meet these important obligations.

About Darnell Yu

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