Loan Refinancing

[MarZDoates]

I've read and re-read the research on this and I'm still confused. If anyone can shed some light, I would certainly appreciate it.

Client borrowed $11,500 in January, 2000 at 10% to be repaid in five years. June, 2002 outstanding loan balance is $8,200. Vested account balance as of June, 2002 is $15,000. He wants to refinance at a lower interest rate.

1. I calculate the maximum additional amount to borrow to be $1,800: (>$15,000 x 50% or $10,000). Maximum is $10,000 less $8,200 outstanding = $1,800. Does this appear to be correct?

2. How do I account for this on paper? Here's how I think it should work: Submit request to investment company for $1,800 and rerun the amortization schedule at $10,000 at new interest rate from this point forward for five more years. Does this sound right?

Thanks in advance for the help.

[jaemmons]

Is the participant's vested account balance inclusive of the outstanding loan balance on June 30? Also, does the loan policy allow for outside collateral, in order to allow for the $10,000 minimum loan?

[MarZDoates]

Good point. The vested balance excludes outstanding loan balance.

[jaemmons]

Okay.

If the participant refinances, and the repayment terms extend beyond the due date of the original loan (the one beying refinanced), you must add the outstanding loan and the replacement loan together to make sure that you don't violate Code Section 72(p)(2)(A). If you do, the replacement loan would become a deemed distribution.

Under you example,

Vested balance plus outstanding loan balance on June 30 is $23,200. $50k limit doesn't apply, so the limit is 50% of $23,200 or $11,600. Since you already have an outstanding loan of $8,200, the maximum amount of additional loan that can be taken is $3,400. Assuming that the refinance does not extend beyond the original payment terms, the participant can refinance the original loan with a replacement loan of $11,600.

If the repayment terms extend beyond the original loan terms, you would have to add the $8,200 (outstanding loan) and the $11,600 (replacement loan) to see if you haven't exceeded the 72p limits. Since $19,800 is greater that the maximum of $11,600, the replacement loan would become a deemed distribution.

This participant really cannot refinance this loan past the original due date without incurring a taxable distribution.

[MarZDoates]

Let's say that we amortize the replacement loan within the original time period. Do I then take the $3,400 difference out of the investment account and rerun the amortization schedule at $11,600? Sorry if I seem dense. Participant loans drive me nuts!

[jaemmons]

Yes. The new loan issuance would be for $11,600 ($3,400 the participant will receive as net loan proceeds after $8,200 is used to "pay off" the original loan and extinguish the debt from the books). I wouldn't apologize because I do not feel that loans should even be offerred within a retirement plan.

[MarZDoates]

Thank you SOOOO much!!