How much can I borrow on my 401K?

[Guest Zoil]

Last month I paid off the remaining balance on a $34,000 loan on my 401K. Pay off was $20,000. I did this because my plan only allows one loan at a time. This month I applied for a $49,000 loan. (I have $100,000 vested in the plan.) My TPA said I could only borrow $25,000 because of Section 72P of the IRS code. He says he must reduce my request by the amount that was owed on the previous loan one year ago which was $24,000. I do not read Section 72P this way as this rule "seems" to refer to outstanding loans. If I am right in believing I should be able to borrow $49,000, how do I convince him he is wrong?

Thank you

[Mike Preston]

Well, this is kind of a complicated situation, so bear with me.

First, it looks to me like both of you might be right. If that is the case, then the Plan's rules will need to be followed, unless you can convince them that they should change the Plan's rules.

Second, some background. The IRS issued some final regulations on the application of 72(p) in July of 2000. Those regulations were effective for loans issued 1/1/2002 or later.

Unfortunately, the section of those regulations that would have helped you convince your plan's TPA that they could accomodate you (which was Q&A 20 from that regulation) was not implemented with the final regulations. Instead, it was marked as "reserved." At the same time that the final regulations were being published, the IRS published some proposed regulations for 72(p). You guessed it: those proposed regulations included the previously reserved Q&A 20. That Q&A is pretty long, so I don't think it is best that I provide a copy of it here. If I can find a link to it on the web somewhere, I'll post it later. But the Q part of that Q&A is:

"Q- 20. May a participant refinance an outstanding loan or have more than one loan outstanding from a plan?"

Found a link:

http://www.bc.edu/bc_org/evp/polpr/govtupd...l3100_46677.pdf

Unfortunately, the proposed regulations have never been finalized. More on that later.

OK, with that as background, let's first talk about the Plan's current rules. Their rules are probably consistent with the TPA's explanation (with one exception - if you can get a supervisor to review the rules, I think you'll find that the limit under the Plan's rules is probably $26,000, which is arrived at by subtracting $24,000 (the highest amount outstanding in the 12 month period before your new loan is established) from $50,000 (the amount you would have been able to borrow today had you never had a previous loan from the plan)). That was, in my opinion, a reasonable interpretation of Section 72(p) prior to the issuance of the proposed regulations. Again, in my opinion, your interpretation that one is merely to ignore previous loans if they are already paid back at the point in time that a new loan is applied for is not reasonable. I don't think any plan in the country used your interpretation.

So, under the current Plan rules, you are probably stuck with a maximum loan of $26,000.

Your job is therefore to gently persuade them that they can, if they want, change the program to recognize the proposed regulations. If you can do that (and I'm not saying it will be easy, because there is nothing that requires them to do so - remember, the proposed regulations aren't yet in effect, because, as best I can tell, they have never been finalized), then you can structure the new loan so that it satisfies the new rules of 1.72(p)-Q&A20 and both you and the TPA will be happy.

The proposed reg on this issue gives you two options:

1) Establish the new loan such that it is completely paid off by the time that the original loan would have come due. It looks to me like you were about 2 and 1/2 years into your first loan, so you could have the $49,000 loan paid off in the next 2.5 years and satisfy the rules.

2) Establish the new loan so that it is really paid off as if it were two separate loans, the first for $20,000 paid off over the assumed 2.5 years remaining on the original amortization and the balance of $29,000 paid off in level payments over the next 60 months. This would mean that you would have payments for, say the next 30 months of about $1,325, then ratcheting down for the next 30 months to about $600. This is a complicated method that I've not heard a lot of TPA's jumping for joy at and it is probably the reason the IRS has not yet finalized the regulations.

Hopefully, this has given you enough information so that you can proceed. Wish I could have offered you more in the way of a definitive method to get what you need.

There are some pretty good consultants and lawyers that frequent this message boad. Maybe someone will come up with something better than I have.

Good luck.

[Guest Zoil]

Thank you for your reply. Now I understand what my TPA is saying. However, I still do not understand why the loan I paid off is caluated into the formula when it was paid in full. This seems like a penalty for paying off a loan early. I read on the board about "bridge loans" to help work around the company's "one loan at a time" policy. This is what I did in 1999. I paid off an existing loan and borrowed 50% of my vested account. ($34,000) They treated it as a new loan and did not reduce it by what was owed on the old loan a year earlier. Now in 2002 the rules have apparently changed and the "bridge loan" is no longer a valid option, which has really confused me.

I appreciate your suggestions. You give me more options to consider. Thanks.

[Mike Preston]

The rules of 72(p) are pretty complicated. Bridge loans are still a valid tool. When you took out your $34,000 loan, it should have been combined with the largest outstanding balance of your prior loan in the 12 month period immediately preceeding the date that you got your $34,000 loan. When those two numbers were added up, the result should not have exceeded $50,000.

A lot of people think that instead of $50,000, you should make sure that the sum of the two numbers doesn't exceed the "50% of account balance" limit. But that isn't the way 72(p) works.

So, as long as the loan you were replacing didn't have more than $16,000 outstanding at any time in the 12 month period before you took out your $34,000 loan, you were ok.

If you had more than $16,000 outstanding on your original loan in the 12 month period immediately preceeding the point in time that you took out your $34,000 loan then the Plan should have provided you with a 1099, and you should have been taxed on the amount in excess of the limit.

[Guest SteveR]

P.S. to Zoil,

The rationale for looking back for the highest outstanding loan balance during the prior year is to prevent the annual rollover of a $50,000 loan, thus circumventing the 5 year payback requirement. Without the lookback provision, participants would be able to payoff the loan balance each year and take out the maximum year after year.

Somebody is always there to spoil the fun.

[Guest Zoil]

Thanks both for your replies. It's a good thing I learn this now. Though disappointed with my present request for a loan, it could have been much worse. In the future I was planning to borrow for a down payment on a home---believing incorrectly that if I paid off a previous loan, I could borrow the max once that loan was paid. It is good to know with any previous loan, whether paid early or to term, one must add a full year to the previous loan's term. And, though after the fact, it is good to know there is no advantage in paying off a loan early. I could have gotten my heart set on a beautiful home, only to be disappointed. Oh, well, I'll just postpone my plan by a year.

Thank you!

[Mike Preston]

You are quite welcome. Those of us in the pension "biz" rarely get an opportunity to interact with participants without a client relationship or two to consider. It is refreshing to "hear" your thoughts on this complicated issue, both before the rules are clarified and after.

Keep the bridge loan in mind, though. Credit is somewhat easier to come by these days than it has been historically. If you find that dream home while you still have a loan from your 401(k), it may be just the ticket.

[Guest Zoil]

Unfortunately, we did get a "bridge Loan" to pay off the $34,000 loan--paid off $18,500 believing we could borrow $50,000. Part of our plan was to pay off the "Bridge loan"--it has a 90 day note, and than pay off all our other bills with the remaining money, leading the way to buying that house 5 years from now with no bills outstanding. Since we can only borrow $25,000, however, it just pays off the bridge loan and not much else. It is a disappointment since we were really looking forward to paying off those bills, and a surprise when we could not get the money we thought we could, especially since we had no problems in 1999. Those it is a disappointment now, I'm still glad we now understand Section 72P.

[Guest Zoil]

I am 100% completely baffled. I went ahead and borrowed what I was told was the max I could borrow, $25,000, though I had requested $49,000, finally feeling that I understood the limitations of Section 72P, re: deducting the previous loan balance of a year earlier and deducting that from the max of $50,000, thus $25,000.

There is a phone number I can call and get current info on my 401K, which includes loans. The new loan for $25,000 is in the system already, though I have not yet received the check. This phone service also gives info on loan availablity, so of course I had to check, believing if I understood Section 72P correctly, the amount available would be zero. Boy was I suprised to hear I had available $24,000. (The new loan minus my current $49,000 vested amount.)

In layman's terms, what this is telling me (1) I could borrow $24,000 should I find a home and want to use that as the down, or (2) that I should give back the check for $25,000 when I get it, turn around and borrow only $1000, paid that off in two months, and then borrow $48,000, which is so much closer to my orginal request than $25,000. In other words, it appears (to me) the computer does not deduct the highest loan balance of the previous 12 months, only the most recent. I am completely baffled because it seems either would go over the $50,000 max in one year rule.......

[Mike Preston]

It sounds to me like the computer's program is just wrong. If you actually applied for another loan, one would think the "humans" would get in the way of allowing the computer to do something wrong.

Call somebody (you might need to ask for a supervisor's surpervisor) and ask whether what you want to do can be done. I'd be very surprised if you got an answer that would in any way allow you to increase your existing loan.

[Mike Preston]

Original messages: "(I have $100,000 vested in the plan.) "

Most recent message: "(The new loan minus my current $49,000 vested amount.)"

Never mind, I don't think I want to know. :-(

[Guest Zoil]

Sorry,

COMPLETELY my mistake. I have $100,000 vested in the plan, I wanted to borrow $49,000.....

[Erik Read]

If you have an 800 # to call, and it's telling you incorrectly the amount that is available for you to borrow, unless you request to speak with your firms administrator (who should be the final authority for your loan request), the supervisors supervisor may still think you can borrow as your suggesting.

In a previous life, working for a large provider, our phone support group took the word of the computer program as gospel truth. Only when the request came to the administration department for signature, would we catch the look-back issues.

Good luck.

[Guest Zoil]

Thank you. I am trying to talk with the TPA, but he is currently on vacation. The problem is, the TPA is relying on their computer to tell me I can not borrow the full $49,000 I requested, (because of Section 72P) but only $25,000, and it is this same computer now telling me that I can borrow an additional $24,000 though my new $25,000 loan (the amount I was forced to accept) was completed only one week earlier.(Which is in complete vioation of Section 72P)

The sage gets worse. I had a supervisor tell me if I had waited 5 days to request my new loan, I could have borrowed the full $49,000! Five days, 30 days, or 120 days--why would I even think to wait five days when I was told by the TPA I could only borrow $25,000 because of the balance on a loan I had one year earlier--the loan I paid off only last month? This supervisor even went so far as to call my office manager to tell her I could do another loan for $24,000 which would equal my orginal request for $49,000, it would just be two loans instead of one. Well, as I know, and as my office manager knows, our program does not allow for two personal loans. Either I can borrow the full $49,000 in one shot as I requested, or I can only borrow $25,000. It can not be both ways.

What concerns me even more, this is a large financial firm that handles my 401K, as well as tens of thousands of others, and if they have computer errors like this, what is happening with the rest of the 401K program? One of the reasons I continue to take loans on my 401K is because over the 13 years I've had it the return has been so poor--I make more on the money I borrow paying back myself the interest rate.

Enough is enough--it is getting way out of hand. I will handle this, but I do thank everyone for their input. :-)

[Mike Preston]

May I ask a favor? Please keep us posted as things develop, even if you don't have further questions. I'm sure I speak for more than myself when I say that there is keen interest in seeing how this actually plays out!

[Guest Zoil]

Will do. :-)

[Guest Zoil]

I did want to follow up on this: After much debate, and the TPA going to his supervisor, I did get the $49,000.00 loan orginally requested.

[Mike Preston]

Thanks for letting us know.

Please review the circumstances I mentioned in my first response to you. Keep in mind that if your new loan is not treated as defined therein (for example, having it mature before 5 years from the date your previous loan was established) the TPA is likely to decide at a later date, even though they approved the loan as requested, that they must nonetheless treat the loan as violating 72(p). If they do that, you will end up with taxable income to the tune of the new loan - $49,000! Since I know that is NOT what you want, please ensure that your TPA absolutely confirms that they will not issue you a 1099 with respect to the loan you are getting (or have gotten).

Glad thngs are working out for you!