Hardship distribution after loan taken....?

[chris]

Assume A's vested balance in PSP account is 50K and A takes out a loan for 25K. Can A then apply for a hardship distribution for the remaining 25K? ERISA Outline Book has an example in the discussion regarding how subsequent distributions don't affect 50% loan limit which would imply that it could be done. However, it doesn't seem prudent from a Plan standpoint b/c the remaining 1/2 of the account is generally held as security for the loan.... Any suggestions? Thanks in advance.

[FundeK]

Yes, the participant can take a hardship after taking the loan. They only need to satisfy the adequate security requirement at the time of origination. Subsequent distributions do not affect the loan's qualified status.

[MoJo]

Pardon my jumping in here, but I think people misinterpret the issue of "security" for a loan from a plan, in cases of earmarked loans (i.e. loans allocated to the account of the borrower). Security for the loan is the asset that is impaired for purposes of offsetting the loan in the event of default. In the example provided here, the security for the loan is the $25,000 balance (from which the actual proceeds of the loan are derived). The "cash" in the plan is replaced by a promissory note. Think of it this way - before the loan, the account has a value of $50,000. Immediately after the loan, the account still has a balance of $50,000, represented by a promissory note in the amount of $25,000, and another $25,000 in other assets. In the event of a default, the ONLY thing that would be removed from the account (at the appropriate time) would be the promissory note, leaving a balance in the account equal to the value of the other assets ($25,000, plus or minus investment experience). Hence, the "other" $25,000 is not "security" for the loan, because under NO circumstance could those assets be attached to satisfy the loan, in the event of default.

My opinion is that the 50% rule had application only in the (old) world where loans were not earmarked to the account of the borrower (and were an assets of the plan allocatable to all participants). In this case, because of the potential that investment experience could erode an account balance, which would be offset in the event of default, that you could only borrow 50% of the balance, to reasonably ensure that there would be sufficient assets to offset the loan in the event of default.

A long way of agreeing that, yep, you can take a hardship of the "other" 50% of the balance, because it isn't security for the loan - and the 50% rule only applies at the time the loan was taken out.

[FundeK]

I think I like MoJo's response better!!

[MoJo]

I charge by the word.... But this issue has been a pet peeve of mine for a while....

Let me throw a wrinkle into this, and see what happens....

Assume the same facts - a $50,000 balance, but assume half of this is attributable to a MPPP that has been merged into a 401(k) plan, with J&S rights preserved ONLY with respect to the MPPP balance. Participant wants a loan of $25,000, and the plan says the only "loanable" assets are the non-MPPP assets, but the MPPP assets are used in calculating the max loan available (i.e. in applying the 50% rule, all assets are included). Is spousal consent required? Arguably, yes, because you use those assets for purpose of calculating the max loan available. Arguably, no, because the MPPP assets are not used to fund the loan, and are NEVER impaired (per the analysis above, because the "other" half of the account really isn't "security" for the loan).

Any thoughts?