Defaulted loan in a DB plan-how to handle

[AndyH]

DB plan has outstanding loan which is being treated as defaulted in year of distribution. PVAB way over $5,000, so distribution cannot be forced. Loan is not going to be paid back.

Plan has a lump sum option which will almost certainly be taken.

Participant is below NRD, is agreeing to the distribution.

One approach might be to take the outstanding loan balance, project that to NRD using actuarial equivalence, determine the accrued benefit equivalent and subtract that from the accrued benefit. That would cause the participant to lose the benefit of the 417(e) rate on the accrued benefit presuming that the 417(e) interest rate is below the AEQ rate.

One might instead argue that the lump sum should be the PVAB of the total accrued benefit and the outstanding loan balance should be debited from that.

Opinions (other than that loans in DB plans are bad ideas for this reason!)?

[SoCalActuary]

When I look to my document, it defines Actuarial Equivalence for 417(e) purposes and separately for other purposes. Is a defaulted loan subject to 417(e) in your plan?

If you argue that loans are a lump sum distribution subject to 417(e), then you offset the loan using the AE rules for 417(e) at the point of the defaulted loan. I suggest this is the correct interpretation, since the loan looks like a single sum payment instead of a periodic payment. However, I can't speak for an auditor who might disagree.

The safe thing to do: Have your loan provisions refer to 417(e) rates in the document.

[AndyH]

Well, of course the document does not address these matters, but I decided that your approach is the fairest. There are actually two things happening in a DB loan default, a deemed distributution of the loan balance, then the offset at the time of payment. The offset does not take place until there is a distributable event so it seems to me that 417(e) is applied to the entire accrued benefit at the time of offset, then the deemed distribution and interim interest is debited from the lump sum (assuming such a choice is made).

Thanks for the feedback.