Advanced Issues With Participant Loans, Hardship Withdrawals and QDROS. Agenda. Hardship Distributions

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1 Advanced Issues With Participant Loans, Hardship Withdrawals and QDROS Presented by: Robert M. Kaplan, CPC, QPA, CFP, APA VP, National Training Consultant Voya Financial Hardship Distributions QDROs Participant Loans Questions Agenda 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 (k) 1(d)(3)

2 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

3 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

4 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 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)

5 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

6 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 5 th Circuit Court of Appeals Sham divorces What is the responsibility of the Plan Administrator in determining whether a divorce is valid or not?

7 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

8 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?

9 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

10 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

11 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

12 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

13 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 Loan is offset from the participant account only at the time that a participant has a distributable event Offsets

14 Same participant who defaulted takes another participant loan Require payroll withholding, or Require additional collateral Default or Offset 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 Refinancing Replacement loan is treated as a new loan for Re-determine interest rate and maximum limits

15 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 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 restarting 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

16 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)

17 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 ) allows for correction of loan operational errors More than maximum Longer than 5 years Defaults Not in plan document! Questions

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