What Is a Loan Audit in a Retirement Plan?

A loan audit within the context of a retirement plan is a vital process designed to ensure that participant loans are managed in strict accordance with both the plan's provisions and relevant legal requirements. This audit involves a detailed review of all aspects of the loans issued by the plan, from their initial approval through to their repayment, to confirm that they comply with the rules set out by the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code (IRC).

The primary focus of a loan audit is to verify that all loans are properly documented and administered. This includes checking that each loan was issued for a valid purpose as defined by the plan, such as buying a primary residence or covering certain medical expenses, and that it adheres to the limits on loan amounts set by the IRS—typically, the lesser of $50,000 or 50% of the participant's vested account balance [1]. The audit also ensures that the repayment terms, including the interest rate and repayment schedule, are consistent with the plan’s requirements and are being followed correctly. Any failure to meet these terms could result in the loan being treated as a taxable distribution, leading to significant tax consequences for the participant [2].

Another critical aspect of the loan audit is ensuring compliance with ERISA's fiduciary standards. Plan sponsors must act in the best interests of the participants, which includes ensuring that the loan provisions are fair and that they do not unduly favor certain participants over others. The audit checks for any potential breaches of fiduciary duty, such as approving loans that exceed the allowable limits or failing to follow up on delinquent loans. Non-compliance in these areas could expose the plan sponsor to legal risks and penalties [3].

Additionally, the audit looks at the timeliness and accuracy of loan repayments. Participants must make regular payments to avoid default, which could result in the loan being deemed a distribution and subject to income tax and potential early withdrawal penalties. The audit will review payroll records or other payment methods to confirm that payments are being applied correctly and on time [4].

In summary, a loan audit is a critical component of a retirement plan’s administration, ensuring that participant loans are handled correctly, fairly, and in full compliance with legal and fiduciary requirements. Regular audits help to identify and correct issues before they become significant problems, protecting both the plan and its participants from unnecessary risks and penalties.

References:

 [1] Internal Revenue Service. (2023). Retirement Plan Loans FAQs. Retrieved from https://www.irs.gov/retirement-plans/retirement-plan-loans-faqs 

 [2] U.S. Department of Labor. (n.d.). Understanding Retirement Plan Fees and Expenses. Retrieved from https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/publications/understanding-retirement-plan-fees-and-expenses.pdf 

 [3] U.S. Department of Labor. (n.d.). Meeting Your Fiduciary Responsibilities. Retrieved from https://www.dol.gov/sites/dolgov/files/ebsa/about-ebsa/our-activities/resource-center/publications/meeting-your-fiduciary-responsibilities.pdf 

 [4] Society for Human Resource Management (SHRM). (2023). Conducting a Loan Audit for Retirement Plans. Retrieved from https://www.shrm.org/resourcesandtools/tools-and-samples/how-to-guides/pages/how-to-conduct-a-loan-audit-for-retirement-plans.aspx 

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