Interest rate charged on loans

[Guest Sara H]

Could anybody tell me what they use to determine the interest rate on loans from 401(k) plans? I know that the plan doc says that a "reasonable rate of interest" must be charged, but I've heard of a couple of ways to determine the interest rate. (i.e. prime + 1%). Any information would be appreciated.

[Fredman]

We use prime + 1%.

[Earl]

I tell clients, "There are no specific definitive rules. Here is the risk (too low, too high). We recommend prime +1 or +2 and under audit have never had a problem. What do you want to do?"

I have asked the first line audit guys, "come on, tell me. What do they tell you is reasonable?" They say, we look at a chart and let our supervisor decide.

[MWeddell]

DOL regulations aren't much practical help (because commericial lenders don't make loans fully secured by participants' account balances, so what exactly is similar) and DOL regulators won't say what they want.

Given that uncertainty, I figure there's safety in numbers. About 70% of plan sponsors use prime rate plus or minus an increment, with prime rate + 1% as the most common interest rate.