5 year repmt, practical considerations

[wvbeachgirl]

Just trying to get a feel for "industry practices" with regard to 5 year participant loans (not residential loans). The regs require a maximum repayment period of 5 years from the loan date. As an example, say the loan is issued 4/14/05; it must be paid in full by 4/13/10. We have run across lately several takeovers (from several different TPAs) where the prior administrator set up the loan payments for 60 months (for example), with a 3 week delay between the loan date and the first monthly payment. Effectively, this makes the loan go past the 5 year requirement. They've all said this is common industry practice. Our feeling is that in order to comply with the 5 year requirement, you would need to reduce the number of monthly payment to 59 (for example) instead of 60 if there's a gap between the loan date and the first payment date. Three questions:

1. IS this common industry practice to count the five years from the date of the first payment rather than from the date of the loan?

2. Has the IRS given an opinion on this practice (other than to say that the loan date could be changed to the date of delivery of the loan proceeds to the participant)?

3. Given that these loans are already issued, what is the client's and/or participant's liability? The INTENT was to comply with the 5 year requirement, but in actuality will not comply since the 5 years was counted from 1st loan payment date rather than loan issuance date. (Which is different than a loan intentionally being amortized over more than 5 years) Will the loans be considered prohibited transactions with the attendant possible disqualification of the plan unless they are corrected through EPCRS?

Thanks!

[Belgarath]

I'm a little confused here. There is always going to be a gap between the loan date and the first payment date. So if you have a loan date of 1/1/07, then the first payment date (on a monthly amortization schedule) will be 1/31/07. The 12th payment will be due on 12/31/07. And so on until the 60th payment will be due on or before 12/31/11. If these other TPA's are using a first payment date of 3 weeks after the loan date, this shouldn't cause any problem.

Are you instead really saying that the 5 year period is starting 3 weeks after the loan date of 1/1/07, so that the first payment isn't due until February 21st? If so, while it may be "common industry practice" I've never seen it, nor would we administer a plan on that basis. I can't answer as to whether the IRS/DOL has given official or unofficial sanction to such a practice. They have apparently said that the date of the loan is the date that the loan check is delivered to the participant, not the date that the loan agreement is signed. This according to Sal Tripodi, who refers to the ABA meeting with the IRS on 5/7/2004.

[wvbeachgirl]

Sorry - I guess a monthly loan wasn't the best example. Let's say you have a weekly payroll with a 3 week gap between the loan date and the first payment. A weekly payment over 5 years would be 260 payments, which is what the amortization schedule reflects. However, this does make the final payment due more than 5 years after the loan date due to the 3 week gap. We believe the amortization schedule should have been done on 257 payments (260 less the 3 weeks with no payment) which would end within the 5 year limit. Agree?

[Bird]

In the scenario you describe (loan made, weekly payments start 3 weeks later) is the initial amount amortized over 260 payments, or is some interest being added and then that amount amortized (I doubt it). If the loan schedule is set up with a regular 5 year schedule and the money just happens to come out a little early, it's not something I'd worry about.

[pmacduff]

I went to a loan & distribution session at ASPPA this year.

The speaker mentioned that there is still controversy over this issue. He said that "the IRC starts the 5 year period from the date the loan is made" however "the TEFRA blue book states that the 5 year period starts with the first payment as long as the payments start within 2 months of the loan origination".

Our loan forms say that the first payment is due "no later than" 30 days after the loan is issued. We have had IRS plan audits and never had this brought up as an issue so long as the repays began within that time frame.

[masteff]

Due to timing of interfaces between TPA and client computers, I've seen it go 45-60 days between date of issuance to date of first payment (which would fit w/ pmacduff's comment about what the TEFRA blue book says).

At my last company (4 plans w/ $1billion assets), we used that "industry practice" and, while I can't say the practice is 100% correct, we did go thru a full audit about 2 years ago.

I suspect part of the logic is that the "term" of the loan is deemed to be the number of payments to be made based on a certain payment frequency, not the duration from issuance to payoff.

[masteff]

In researching a new question, I happened on this thread again and finally followed up completely on pmacduff's reference to the TEFRA "Blue Book". Below is a link to that document. My take away is if the first periodic payment is within 2 months of the loan date then the 5-year amortization starts from the first payment's due date. Otherwise it starts from the loan origination date and a payment schedule that extends beyond that will violate the amortization requirement and therefore be a distribution.

https://www.jct.gov/publications.html?func=startdown&id=2381