Hardship availability after taking a loan

[Guest tajcc]

If a person has taken a loan, does the loan reduce the amount of the hardship availability if they have paid a portion of the loan back?

Say a person had contributions into the plan of $10,000.00 - took a loan for $7,000.00, loan balance is now $5,000.00. What would the hardship availability be?

[Guest Sieve]

Not enough facts to give a full answer, but try this on for size . . . If safe harbor hardship provisions apply to the plan, then, generally, all loans available to the participant from the employer's qualified plans must be taken before the hardship distribution occurs (check the plan to see if this provision applies). In your scenario, I assume that the participant's aggregate balance is at least $14,000, since that would permit a loan of $7,000 (unless additional security other than the account balance were given)--under DOL regs, an account cannot be used as security for a loan if the loan exceeds more than 1/2 of the account balance when the loan is taken. So, using my assumptions, another loan of an additional $2,000 would have to occur (bringing the loan balance to $7,000 with respect to $14,000 in the accounts)--unless the Plan does not permit an additional loan, e.g. because the plan does not permit a 2nd loan or a refinancing--and then the remaining portion of the account balance subject to hardship withdrawal could be withdrawn for the hardship.

[masteff]

Not enough facts to give a full answer, but try this on for size . . . If safe harbor hardship provisions apply to the plan, then, generally, all loans available to the participant from the employer's qualified plans must be taken before the hardship distribution occurs (check the plan to see if this provision applies). In your scenario, I assume that the participant's aggregate balance is at least $14,000, since that would permit a loan of $7,000 (unless additional security other than the account balance were given)--under DOL regs, an account cannot be used as security for a loan if the loan exceeds more than 1/2 of the account balance when the loan is taken. So, using my assumptions, another loan of an additional $2,000 would have to occur (bringing the loan balance to $7,000 with respect to $14,000 in the accounts)--unless the Plan does not permit an additional loan, e.g. because the plan does not permit a 2nd loan or a refinancing--and then the remaining portion of the account balance subject to hardship withdrawal could be withdrawn for the hardship.

Sieve - I have to disagree to some extent. 1) we can't assume the availability of more than 1 loan at a time; while permitted, the regs don't mandate multiples. 2) in a generaly reading, the regs only require the participant to have taken a loan, not the absolute maximum. The participant doesn't have to "tap out" all loans before a hardship can occur. To me, IMO, that's an overly strict reading of the regs. This is based on my 8 years in corporate benefits administering four 401(k)s w/ $1B+ combined assets. In the most common reading of the regs, the participant only has to take the plan minimum loan.

While you're interpretation is fundamentally correct and is the more conservative approach, there is a body of practice that has passed IRS scrutiny/audit that is less conservative but stays w/in the regulatory boundary.

tajcc - Does the plan have any money other than employee pre-tax contributions? If so, you'd need to review your plan for source heirarchy. Plans typically take loans from non-pretax monies first. This leaves the most funds available for a hardship. Next question is does the plan limit hardship to pre-tax contribution source? If so, then the hardship is limited to the current pre-tax balance (having subtracted out any amount attributed to a plan loan).

Basically, you follow the plan rules to subtract out the CURRENT loan balance from the appropriate sources and then determine the balances of the sources available for hardship. You can then allow withdrawal for the lesser of a) the documented need plus gross up or b) the balance available for hardship.

[Guest Sieve]

masteff -- Thanks for the practical info re: loan requirements prior to hardship distributions. Strictly on their face, I believe the regs require that all permissible loans be taken: "all other currently available . . . nontaxable loans" is pretty clear to me. I don't see how that is an overly strict reading of the regs. If, however, you can show that taking the loan would be counterproductive, then the requirement to take all permissible loans is trumped--and, in that case, my approach may be too conservative. I didn't discuss that issue in my post, but I do believe that the counterproductivity argument is often available. In any event, I've never had the hardship distribution & loan relationship reviewed on a client's IRS or DOL audit, so I had no idea that the IRS might not require that all loans be taken. As I said in my post, a second loan certainly would not be required, even under my conservative approach, if the plan only permits one loan at a time.