I would really appreciate the expertise of this group on the following unusual set of circumstances:

There is a married couple who work for our law firm. Both are non-lawyer, support staff and younger than 59 1/2.

The husband took a plan loan from the firm 401(k) plan to purchase a home. The individual to whom they paid this amount has since absconded with the money and never sold them the house.

The firm is going to help these folks bring a fraud action against that individual. In addition, I have been asked to try to figure out whether there's any potential relief on the plan loan front. They are currently making payments on the loan through payroll deduction, as the plan requires. They are now experiencing some financial difficulty and finding the loan payments difficult to make. Our plan does not allow for hardship distributions.

From their perspective, it looks to me like the best course (other than being able to pay back the loan) would be to intentionally default on the loan and then try to work out either a compromise or a payment plan witih the IRS when the taxes come due. Their facts are pretty sympathetic and the IRS might be willing to work with them.

But I just don't see any way for them to do that since payroll deduction is required as long as the employee is receiving pay from the firm. Am I correct that there's no way the plan could agree to stop the payroll deductions and allow them to default? My sense is that would be a breach of the fiduciary duty to enforce the terms of the loan, as well as a breach of the terms of the plan document.

Any thoughts on anything else these people might be able to do with respect to this plan loan? Many thanks in advance for your thoughts.

Julie

It is my understanding all states do not allow the "mandatory" payroll withholding to repay plan loans. If the state you are in is one of those, the employees simply may change their payroll withholding to no longer repay the loan.

Our plan requires payroll deduction for loans too, but our loan procedures provide that the revocation of authorization for payroll deduction is a loan default event. Check all of the detailed language that might apply to loans under your plan. Otherwise you could add this as a default event in your loan procedures without going through the process of a formal plan amendment. Our plan requires Board approval to amend, but the administrative committee can amend the loan procedures. Loan defaults are brutal because of the early distribution tax. Why don't you amend your plan to allow hardships?

with hardships you still get banged with the early distribution tax.

plus the 6 month suspension (in most cases). at least with a loan you get to reinvest the money.