Benefit payments, distributions and participant loans

• Test distributions for eligibility, vesting, calculation and authorization
• Apply the Code section 72(p) loan limits and repayment rules
• Identify defaulted loans and deemed distributions
• Evaluate participant loans under the ERISA section 408(b)(1) exemption

Distributions

Distributions are the main outflow of a defined contribution plan and a common area for errors and fraud. For a sample selected from the recordkeeper's distribution report, test that:

• the participant was entitled to a distribution under the plan (termination, retirement, age, disability, death, hardship or another plan-permitted event);
• the distribution was authorized, with a signed or authenticated request and spousal consent where the plan's annuity rules require it;
• the vested percentage applied was correct under the vesting schedule;
• the amount agrees to the account balance as of the valuation date, less any withholding; and
• the check or transfer cleared to the participant or to a rollover account in the participant's name.

Test distribution completeness too: compare terminated employees with balances to the distribution report, and compare large distributions to termination dates in payroll. A distribution to an active employee who does not qualify for an in-service withdrawal is a red flag.

Hardship withdrawals. Confirm the plan permits them, the reason is one the plan allows, and the documentation or certification the plan requires was obtained.

Required minimum distributions. Test that participants who reached their required beginning date received distributions under Code section 401(a)(9). The RMD calculator helps recompute amounts.

Participant loans

A participant who is an employee of the sponsor is a party in interest (ERISA section 3(14)(H)), so a loan from the plan to that participant is a prohibited transaction unless it meets the ERISA section 408(b)(1) exemption. That exemption requires loans to be available to all participants on a reasonably equivalent basis, made in accordance with the plan's provisions, bearing a reasonable rate of interest and adequately secured.

To avoid being a taxable distribution, the loan must also meet Code section 72(p):

• Amount: no more than the lesser of $50,000 or the greater of one-half of the vested account balance or $10,000.
• Term: repayment within five years, unless the loan is used to buy the participant's principal residence.
• Payments: substantially level amortization with payments at least quarterly.

Defaults and deemed distributions

If a participant misses a payment, the plan may allow a cure period that cannot extend beyond the last day of the calendar quarter following the quarter in which the payment was due. If the loan is not cured, it becomes a deemed distribution, reported to the participant on Form 1099-R. The auditor tests that defaulted loans are identified and treated under the plan's policy and the Code.

Audit procedures for loans

For a sample of new loans, inspect the application and promissory note, and recompute the maximum amount using the vested balance on the loan date. Check the interest rate against the plan's loan policy. Trace disbursement to the participant. For a sample of outstanding loans, recompute the amortization and trace repayments from payroll withholding to the plan, which also feeds the timely remittance test. Loans are presented as notes receivable from participants. The loans and benefit payments workpaper lays out the attributes.

Common file mistakes

• Distribution sample drawn and tested only for the amount, with no eligibility or authorization test.
• Loan maximum recomputed on the total balance instead of the vested balance.
• Missed loan repayments with no cure analysis.
• Loan repayments withheld but not remitted on time, with no line 4a consideration.

Clearwater Foods 401(k) Plan: was the loan within limits?