401(k) Rescue, the Ekon Benefits 401(k) Fix-It Series, describes the most common 401(k) mistakes as determined by the IRS. We provide explanations of common mistakes, suggested prevention techniques and recommendations on correction methods.

Common Mistake #9: Participant Loans

Participant loans are allowed in 401(k) plans, as specified in the plan document, but they must adhere to a specific set of rules outlined in IRC Section 72(p). These rules include:

• Loan Agreement: The loan must be documented with a legally binding agreement that includes the loan amount, date, repayment term, and amortization schedule.
• Loan Amount: The loan generally cannot exceed the lesser of $50,000 or 50% of the participant’s vested account balance. Plan terms may dictate minimum loan amounts.
• Repayment Schedule: Participants are required to make level amortized payments at least every quarter. The loan and accrued interest must be fully repaid within five years, unless the loan was used to purchase the participant’s primary residence.
• Leave of Absence: Loan repayments may be suspended for up to one year during a bona fide leave of absence, but the loan must still be repaid within the original term. After the leave, repayments must resume and the loan must be re-amortized or repaid in a lump sum.

How to Correct Loan Errors

If a participant loan fails to comply with IRS limits or plan rules — for example, due to exceeding loan limits, extending beyond the permitted term, or missing repayments — the loan may be treated as a deemed distribution subject to taxation.

However, under the expanded Self-Correction Program (SCP) available through Rev. Proc. 2021-30, many loan-related failures — including missed payments or documentation issues — can now be corrected without IRS approval, as long as the plan has established compliance practices and the correction is made within three years of the failure.

In cases where SCP is not available (such as for loans that exceed statutory limits or are not evidenced by a loan agreement), the Voluntary Correction Program (VCP) may be used. Plan sponsors can request that the IRS waive taxation on the deemed distribution as part of a VCP filing.

Preventing This Error

To prevent errors related to participant loans, ensure that the plan document clearly outlines loan procedures. Include systems for determining loan terms, repayment schedules, and documentation of exceptions to the general rules in IRC Section 72(p).

For a complete listing of the most common 401(k) mistakes, please visit the IRS 401(k) Plan Fix-It Guide. For assistance in correcting a plan error, please contact Ekon Benefits at (314)367.6555 or info@ekonbenefits.com.