adding loan policy

[Lori H]

a 401(k) is considering adding a loan provision to its current plan in order to allow certain executives to purchase stock of the plan sponsor, which is privately held. Is there anything in the code that would forbid such an amendment? Off the top of my head, I can not think of anything, but there might be some party in interest issues that I have not considered. The loan provision will be available to all participants and non discriminatory.

[masteff]

Just to clarify, let's break this into two pieces...

1) The plan wants to add loans in a non-discriminatory manner (ie, allowed to every participant).

2) The company's overall objective in adding the loans is to allow certain execs to have a means of financing purchases of company stock.

As long as the enabling amendment and the loan documents don't directly tie the loan provisions to the execs ability to make a stock purchase... I see no problem (but am happy to hear opinions from greater minds than mine).

What the employee does w/ a loan is not material to the plan. Whether I buy a cotton candy machine, put the money in my mattress or buy stock of any company (including my own), is of no consequence to the plan because it occurs outside the plan.

The problem would be where they start wanting the loan proceeds to go directly from the plan to the company. That's where I'm in a grey area of knowledge. I'll just say that I'd rather the check go the participant and then the participant remits money to the company for the entirely separate transaction of the stock purchase. (I could probably tolerate the participant endorsing a loan distribution check over to the company, if the respective banks didn't have a problem w/ it.)

[Lori H]

that was what we ascertained as well. The subject came up with the plan buying shares of the company stock, but that would most likely be a prohibited transaction. Adding the loan provision seems a lot cleaner, although are there ever "clean" loans in QRP's. fun fun fun

[J Simmons]

Lori H,

If the loan policy and enabling amendment as discussed is adopted, and later the sponsoring employer wants to withdraw the loan policy, you might have a problem if the loan 'window' is too short. It might be that when viewed in a broader term, offering the loans for a short window is discriminatory in that its timing is for execs to buy company stock. The company might want to consider now, before going forward, that if it does but later wants to stop plan loans, the company might need to continue them for longer than desired to avoid the timing of allowing loans being discriminatory, or to actually be for the benefit of the employer rather than the employees.

[Guest Kabert]

I take it the company is in dire straits, or perhaps a family business, or both, if its purpose in doing this is to enable more executive ownership of stock (in order to funnel more cash to the company bank account). If it really wants to get execs to be more significant stockholders, why not set up a stock-based plan instead, or a stock fund as a plan investment option?

I guess I don't see a problem with it as long as it's set up as you say, and provided all the reg rules are complied with, including ensuring a proper commercially reasonable interest rate and loan repayment via automatic salary reduction. If executives are being leaned on to do this by the CEO though, I suppose there could be exclusive benefit and fiduciary issues. On the other hand, I can certainly imagine a glory days Enron-type company where the employees want to use any cash they can get their hands on to buy the company stock.

[Lori H]

Lori H,

If the loan policy and enabling amendment as discussed is adopted, and later the sponsoring employer wants to withdraw the loan policy, you might have a problem if the loan 'window' is too short. It might be that when viewed in a broader term, offering the loans for a short window is discriminatory in that its timing is for execs to buy company stock. The company might want to consider now, before going forward, that if it does but later wants to stop plan loans, the company might need to continue them for longer than desired to avoid the timing of allowing loans being discriminatory, or to actually be for the benefit of the employer rather than the employees.

Good point John. I will certainly pass along that the loan policy can not be a temporary program.