Can a plan institute a creditworthiness requirement when deciding whether or not to issue a loan?

[k man]

can a plan institute a creditworthiness requirement when deciding whether or not to issue a loan? the regs say there must be adequate security but if the account this is satisfied if the loans is secured by the participant's account balance. does this in effect satisfy any collateral requirement?

[QDROphile]

I think it is a good idea to form a belief that the participant will make payments. Usually this is satisfied by a payroll deduction or assignment of pay feature, plus an employed participant. The written plan terms or loan policy should address the issue. Unless there is a reasonable expectation of loan payment, what differentiates the loan from an unpermitted in-service distribution?

Illustration: If the plan administrator knows that the particiant will be laid off next week, no loan unless some other information is provided that shows that the participant is likel to be able to pay. What does that say about the current practice of automatic paperless loans?

One could argue that, as a practical matter, once a participant is terminated, an loan will have the same effect as the distribution the particpant could have received after termination. But loans are not supposed to be the same as distributions and need to be treated appropriately.

[Alf]

The DOL wants us to consider it in setting the interest rate. It is a secured loan, so no lender would deny a loan to a bum, but they would jack up the interest rates, which I think the administrator has to do under the literal DOL regs. Also, note that the December final regulations require additional collateral for future loans for someone who has defaulted on past loans, which sounds correct to me.

[GBurns]

Are plans even allowed to receive and use credit information for this purpose?

[k man]

take it one step further - what if the employer knows the employee is going to stop repayment of the loan soon after taking it? does he have an obligation to protect plan assets. on the other hand does the fact that the loan is secured by the account balance negate this concern?

[R. Butler]

That wouldn't be a bona fide loan.

[E as in ERISA]

The "reasonably equivlent basis" rule in DOL regulations 2550.408b-1(a)(4) says that creditworthiness may be a factor in making loans.

[Belgarath]

I think creditworthiness can be a valid consideration. For example, what if the participant is in all kinds of financial trouble, is a bad risk, and is likely to suffer other loan defaults, etc. - even payroll deduction might not help if wages are garnished to satisfy other obligations. I have no idea what debt obligations take precedence. And if the assets have dropped in value, there's a potential loss to the plan. This is probably less a concern in individually directed account plans like a 401(k).

In the real world, I've not seen much evidence that this issue is generally considered by Plan Administrators/Trustees when granting loans.