Jump to content

Rebalance 401(k) Account / Participant Loans


austin3515
 Share

Recommended Posts

Here is an interesting question.  Participant has $10,000 of Fund A in his 401(k) account and $5,000 of a participant loan in his 401(k) account.  He also has $7,000 of Fund A in his Match account. 

Can I have the participant sign an investment election to rebalance his portfolio and shift $5,000 of Fund A from his Match Account to his 401(k) account, and then transfer $5,000 of his loan from his 401(k) account to his match account.

His 401k account would be reduced by the $5,000 loan leaving, but increased by $5,000 of Fund A being transferred in. As a result, the account has the same balance in the end.  The same thing happens in reverse order on the match side.

Is there anything in a reg or whatever that indicates the source of a loan can never be altered?  There is much in the rules that is quite clear that loans are INVESTMENTS like any other.  A consequence of that definition is that this should be doable.

 

Austin Powers, CPA, QPA, ERPA

Link to comment
Share on other sites

I don't know if the loan even comes into play here. Under what circumstances (other than an in-plan Roth rollover) would a participant be able to change the money type of funds that are in the plan? It sounds like this proposal would let him take a $5,000 loan from 401(k) money and repay it as matching money. I don't believe that would count as an investment change or portfolio rebalancing, regardless of whether a loan exists or not.

If it were a case where he had his 401(k) money in Fund A and his matching money in Fund B, I don't see why you couldn't say that the loan taken from Fund A can be repaid instead to Fund B, but that doesn't turn it into matching money; it's just 401(k) money that's now sitting in Fund B. And since you mentioned both money types are invested in Fund A, it doesn't sound like that's the situation here.

Link to comment
Share on other sites

Well, I guess my point is, where is the clarification that a loans sources are fixed at the date of the loan? Where is it "ruled" that you cannot rebalance a loan into other sources in exchange for mutual funds?

If for example, Participant A had $5,000 in Fund A in his 401k account, and $5,000 in Fund B in his match account, he could clearly "switch" and put his $5,000 of Fund B in 401k and $5,00 of Fund A in Match.  Because loans are INVESTMENTS, why can I not do the same thing?

Austin Powers, CPA, QPA, ERPA

Link to comment
Share on other sites

A "pension celebrity" just said he doesn;t see a problem with it. For anyone who wants to steal my idea (I'm giving it to you anyway, so need to steal it!) he said just make sure you take into account accrued interest at the date of the "transaction" when figuring out how much money to shift around.

Austin Powers, CPA, QPA, ERPA

Link to comment
Share on other sites

Austin, you have me lost....

I've only seen a loan investment as a balance to be paid.   Or to say another way, the loan investment is not held as a mutual fund or other investment vehicle.

So if Participant A had a balance of 20,000 (all sources) and wanted to take a loan of 10,000.  All of it was in Fund A.  (10,000 in deferral, and 10,000 in match)  The loan was prorated across all sources, to be paid back to said sources.  Fund A would have 10,000 sold to cash for the loan check.   Source wise, I see Fund A as 5,000 in deferral, Fund A as 5,000 in match, and 10,000 in loans.  (20,000 total balance) 

If Participant A wanted to rebalance his investments to 2 new funds, the account would show 5,000 in Fund B, 5,000 in Fund C, and 10,000 in loan investment. Still 20,000 balance.  Source wise, it would show Deferrals as 2,500 in Fund B and 2,500 in Fund C.  It would show match as 2,500 in Fund B and 2,500 in Fund C, and 10,000 in loan investment.  Still 20,000 balance.

I don't or wouldn't see any reason to move anything around.

Does your recordkeeping system show the loan as invested in actual Funds? 

In my scenario above, the participant would be able to rebalance and transfer at will.  Daily plan, of course.

Link to comment
Share on other sites

6 minutes ago, Mr Bagwell said:

Does your recordkeeping system show the loan as invested in actual Funds? 

I'll just focus on this question. Yes, absolutely.  And it must because the loan payments must go back to the originating source.  I don;t know if that answers your other questions.

Austin Powers, CPA, QPA, ERPA

Link to comment
Share on other sites

Our documents typically specific which sources are available for loan. Some say pro-rate across available sources, others restrict it to 100% vested sources, others restrict it to deferral (pre-tax and or Roth), and other still restrict to Non-deferral sources. Other have a hierarchy for loan proceeds sources. 

I've never heard of the participant getting to choose which sources the loan is taken from  - or in this case repaid to. Which is what you seem to be asking, if I'm understanding it correctly. 

For example:

If the loan is from an employer source and the loan is defaulted and the plan allows distributions from ER sources the loan can be offset and the plan does not have to track it. If the loan had been taken from deferrals, depending on the participant's age, offset might not be an option. Then the defaulted loan would have to be tracked until an offset event occurred. 

Similarly, if a participant is allowed to take a loan from a non-vested source, and then defaults on it - how would you propose the plan account for it? If your scenario is allowed, a person could take a loan from their deferral $, transfer the loan to an unvested match source, then quit. All sorts of problems would ensue. 

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

Link to comment
Share on other sites

I'll just point out that I am doing this as a result of some extenuating circumstsances.  We're not making this a normal part of the plan.  I would not be doing this if it wasn't a home-run solution for a particular set of problems that I had on a plan.

Austin Powers, CPA, QPA, ERPA

Link to comment
Share on other sites

3 minutes ago, austin3515 said:

 We're not making this a normal part of the plan.  

Are you making this option available for a short time only to a specific employee? Cause that seems like something that would need BRF testing....and could easily be discriminatory (assuming it's even allowed - which I'm of the mind it's not - but I open to being convinced otherwise). 

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

Link to comment
Share on other sites

My concerns are similar to @justanotheradmin...  

Do the sources have the same restrictions?  Otherwise I wonder if it could create  a distribution disguised as a loan kind of situation, similar to taking a loan with no intention to repay...

 

If I have $10,000 PS and $10,000 401(k)

In service is allowed at Age 50 for PS and 59 1/2 for 401(k)

P is 52, and takes a loan of $10,000, split evenly over PS and 401(k) 

P then transfers $5,000 loan "investment" from PS to 401(k) in exchange for $5,000 cash

P then takes an in-service from PS of $10,000, leaving the account with $5,000 cash

P then defaults on loan obligation to 401(k)

Is it different if P is 62 and could take an in-service from both sources?

 

 

Link to comment
Share on other sites

So is the question ultimately "where does it say that you can't arbitrarily move plan assets from one money type to another?" (I don't know the answer offhand, but it must be out there!)

If this were permitted, what would stop a participant from taking non-vested employer money out as part of a loan, then declaring that they'll be repaying the loan as 401(k) money as a result of investment "rebalancing"? As an example...

A participant has a 401(k) balance of $5,000 and a PS balance of $5,000; he's 0% vested in the PS money. He takes a $2,500 loan, which is pro-rated as $1,250 from 401(k) and $1,250 from PS. He "rebalances" his investments, declaring that the entire loan is now a 401(k) directed investment to be repaid to the plan as 401(k) money. He pays the loan back immediately, and now has $6,250 in his 401(k) account and $3,750 in his profit sharing account. He terminates the next day and takes his vested balance, which has jumped from $5,000 to $6,250 overnight simply because he "rebalanced" his loan.

(Edited to fix loan amount, obviously he can only take 50% of the vested portion!)

Link to comment
Share on other sites

My last comment on this is as follows:  Those of you who are nay-saying are taking the position that a loan and a mutual fund are different with respect to rebalancing.  My position is that it is no different.  The whole point of all the loan rules (commerically available interest rate, etc) is specifically because it is an investment

Here is an example that nicely underscores my point.  Let's assume a small plan has 2 brokerage accounts for one participant.  One account is for employee money and the other is for match.  Let's say there is a corporate bond worth $10,000 in the 401k brogerage account.  Now, if the partcipant wants that corporate bond in his match account.  So he transfers $10,000 worth of mutual funds into his 401k account, and moves the $10,000 bond into his match account.

Now if you say that's fine, I just say it's the same scenario precisely to what I have described above.  A loan is a loan is a loan.

Austin Powers, CPA, QPA, ERPA

Link to comment
Share on other sites

49 minutes ago, austin3515 said:

My last comment on this is as follows:  Those of you who are nay-saying are taking the position that a loan and a mutual fund are different with respect to rebalancing.  My position is that it is no different.  The whole point of all the loan rules (commerically available interest rate, etc) is specifically because it is an investment

Here is an example that nicely underscores my point.  Let's assume a small plan has 2 brokerage accounts for one participant.  One account is for employee money and the other is for match.  Let's say there is a corporate bond worth $10,000 in the 401k brogerage account.  Now, if the partcipant wants that corporate bond in his match account.  So he transfers $10,000 worth of mutual funds into his 401k account, and moves the $10,000 bond into his match account.

Now if you say that's fine, I just say it's the same scenario precisely to what I have described above.  A loan is a loan is a loan.

I hate to be a nay-sayer! I think calling a brokerage account a "401(k)" or "match" account is confusing matters. Say your example participant had $10,000 in corporate bonds in Account A and $10,000 invested in mutual funds in Account B. You can call Account A "401(k) account" and Account B "match account" but moving money from Account B to Account A doesn't (for example) remove the vesting requirement and impose age 59-1/2 withdrawal restrictions from that money, or vice versa.

If he has $10,000 in Account A as 401(k) money and $10,000 in Account B as match money and takes the loan out from Account A, he can repay it to Account B if he chooses, but that doesn't mean it's match money. It's 401(k) money that's being repaid to an account that happens to be referred to as the "match account".

Edit: am I completely misreading what you're suggesting? It's been a long day!

Link to comment
Share on other sites

Well my brokerage account example was merely to make it plausible to move the bond between the accounts.  And we definitely have clients who earmark a brokerage account for employee money and a separate one for employer money, and I see know reason why securities of equal value could not be shifted between them.

But now you've made a liar because I said the last one was my last post!

Austin Powers, CPA, QPA, ERPA

Link to comment
Share on other sites

So to keep things simple, Austin 3515, say you have two money sources in a non-safe harbor 401(k), (a) nonelective/"profit sharing" and (b) elective deferral. Plan of course has separation from service or age 59-1/2 distribution restrictions for elective deferral, lets you take nonelective/"profit sharing" at any age as long as you are 100% vested. Pre-loan, participant has $50k elective deferral, $50k nonelective/"profit sharing." Takes a loan for $50k. Suppose the plan document does not address where the loan is taken from, but in operation the recordkeeper in next statement shows the loan is allocated 50/50 between the elective deferral and nonelective/"profit sharing," and shows the mutual fund investments also as allocated 50/50, at least immediately after the loan before any new contributions of either type have been made. Suppose they have always done it this way, and do it that way for all other participant loans.

Participant is 100% vested and needs $50k cash for some reason. First answer, "Sorry, you have only $25k in your nonelective/"profit sharing." But then you think about it a little more and say, "Well, tell you what I will do. Just for you, I will swap the half of your loan that is in the nonelective/"profit sharing" into your elective deferral, and the half of the mutual funds in your elective deferral into your nonelective/"profit sharing." Then you can clean out the $50k that will now be in your nonelective/"profit sharing." Is that an example of what you are talking about austin3515?

I think most plans are going to have language or rules that require the loan to be allocated across all money types, and so the IRS in such a case could argue that your "swapping" was really just a disguised $25k distribution from the elective deferral account. In the absence of any such language, I can still see the IRS arguing that you are stuck with how the TPA operationally allocated it when the loan was disbursed, but don't know if they would win.

Or maybe the above is not what you are asking?

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

Link to comment
Share on other sites

Yes, but this is what I said earlier about this:

5 hours ago, austin3515 said:

I'll just point out that I am doing this as a result of some extenuating circumstsances.  We're not making this a normal part of the plan.  I would not be doing this if it wasn't a home-run solution for a particular set of problems that I had on a plan.

 

Austin Powers, CPA, QPA, ERPA

Link to comment
Share on other sites

I've never heard where you can move money between sources (deferrals vs match vs profit sharing) as some have attached restrictions on loans/withdrawals/vesting, etc that others do not.  You can move money between funds/investments.  The loan however is sourced from specific sources and goes back prorata to those sources. I can't say I've ever seen loan balances invested in those same funds, because in the end, it's play/phantom money that does not exist in the bank/trust.  

But I am a dinosaur and your use of funds and accounts is not how I would have defined them...  A participant's total balance is a matrix/table of  sources and funds. Other than moving in our out of a LOAN source (by taking a loan or repaying it), I can't say I've seen reclassified sources except some vague rememberance of being able to reclassify some contributions back in the olden days of ADP/ACP nondiscrim testing (way before safe harbor and the nondiscrim rule changes)..... and if I remember correctly, the employer could only move match into deferral since it became 100% vested....but I could be wrong on that...it was the 90s after all!

Link to comment
Share on other sites

Well, maybe I'm pointing out the obvious - but plenty of plans/sponsors/participants have extenuating circumstances. I think we've likely all lived through a recession or two, seen companies go bankrupt, lay off workers, walk away from unfunded plans, seen business owners lose their homes etc. Just because there are extenuating circumstances doesn't mean the action is allowed. 

Also - what does the loan note say? Was there any other loan paperwork (such as payout instructions) that specified the sources and repayment process?

The one we use references a security interest in the vested interest of the Participant's benefit in the plan. If the participant is not fully vested in the match source you propose using - or vested enough to cover the loan balance - the other arguments against notwithstanding, I don't see how the loan could be shown as being part of non-vested money. 

Also you'd have to make sure the plan even allows for different investments by source. I've seen participant requests to invest Roth money differently than pre-tax money for example, and not all recordkeepers are able to accommodate that, even if the plan wants to allow it. If you are using balance forward brokerage accounts that wouldn't be an issue. 

I'm still of the mind it's not permitted, but even if permitted there would be numerous issues. 

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

Link to comment
Share on other sites

That's why I'm thinking some of us (including me) might be misunderstanding what you're suggesting. I don't think anybody believes loans aren't investments -- well, I hope not, anyway!

As long as the loans are being repaid under the same money type as they were taken out from, I don't think what you're suggesting is an issue. It just wasn't clear to me whether what you're proposing is that the loans can merely be repaid to a different investment option than the one they were taken from (which I think is reasonable) or whether they can be shifted to another money type entirely (which I think is less reasonable).

In other words, based on the wording in your original post

Quote

Can I have the participant sign an investment election to rebalance his portfolio and shift $5,000 of Fund A from his Match Account to his 401(k) account, and then transfer $5,000 of his loan from his 401(k) account to his match account.

my question would be "Is the end result that the participant now has $5,000 of matching money in his '401(k) account' and will repay $5,000 of 401(k) money to his 'match account'?" If the answer is yes then I think this is doable as long as you've got good enough notes to explain to Future Austin why this participant has 401(k) money in the "match account" and vice versa. If the answer is no, I don't think the reasoning that it's okay because the final balances will ultimately work out the same (assuming the loan is fully repaid, and only because the participant is fully vested and happens to have all money invested in Fund A) is especially reassuring.

Link to comment
Share on other sites

I really think my transferring the bond example above is about as clear as I can possibly be.  You just change the bond to a participant loan in my example.  And I said there, but will repeat.  There is no difference between a bond and a participant loan, because they are both loans.

A lot of you keep suggesting too that I'm allowing impermissible distributions, etc., buit if you read carefully the balance in 401k never changes.  I know some reports will not report the loans broken out in their respective sources, and insted just report the loan in total, but the loan is allocated to soruces nonetheless, and my 401k balance in my examples never changes. 

Austin Powers, CPA, QPA, ERPA

Link to comment
Share on other sites

So - Here's a question - is this really necessary? Does the plan allow for more than one loan?

Based on your fact pattern

Deferrals $10,000 real money, $5,000 Loan = Total $15,000

Match $7,000 real money = Total $7,000. I'm going to assume 100% vested. Analysis would obviously be different if not. 

Total Account balance $22,000

Maximum Loan 50% = $11,000

Current outstanding loan balance $5,000

If the plan allows for a new loan - New loan maximum amount $6,000 (assuming there isn't an issue with the high loan balance within the 12 month lookback period). 

Take a NEW loan from Match - repay the old loan into deferrals, problem solved. 

I'm sure the actual numbers are different, but if the total account balance is large enough, it might be doable. 

I'm a stranger on the internet. Nothing I write is tax or legal advice. 

I'd like a witty saying here, but I don't have any. When in doubt, what does the plan document say?

Link to comment
Share on other sites

a) Participant has max # of loans already

b) The plan sponsor has agreed to pay for the tax impact of the default so the participant is whole anyway. Because taxation is unavoidable anyway, they didnt want the guy to have go through all that trouble. PLUS we would end up with basis in the plan, and my feeling is that basis is almost never accounted for correctly in the long-term.

c) We just wan the loan and the problems with it to go away.  Hence trying to rebalance the account to put the loan in a source that is currently distributable.

Austin Powers, CPA, QPA, ERPA

Link to comment
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
 Share

×
×
  • Create New...