Hardship after a loan

[CJS07]

I have a participant who currently has 2 outstanding loans and the plan does not allow for a third nor would he qualify if the plan did allow. He does qualify for a hardship and his "need" exceeds the balance in his account. He has also deferred more than is currently in his account so he would in theroy be able to take 100% of his account balance. I wasn't able to find anything in the plan document addressing this issue but it seems odd to me that he could wipe his account out yet still have 2 outstanding loans. Would we also have to consider the loans as defaulted or could he continue to repay them? And can he really take 100% of his account balance since then there would be nothing securing the 2 outstanding loans??? (The trustee doesn't want to get into using outside assets to secure the loan). Thx

[K2retire]

Lots of details here that I'm unsure about, but I am comfortable saying that if the account balance would not be available as collateral for the loan, alternate collateral would be required.

[Guest Sieve]

CJS --

This participant certainly cannot withdraw from the account any amounts which secure the loans, but any portion of the account in excess of that security can be distributed. Since the loans are held as assets of the account, they will continue to be secured, probably by that portion of the account used for the loans. (In other words, as I understand it, if $25,000 in loans were taken from a $100,000 account, and the account is now worth just $60,000, the loans would represent $25,000 of that $60,000, and the remaining $35,000 could be withdrawn.)

One question you should answer is whether the loan documentation uses a rolling 1/2 of the account balance as security for the loan or a specific dollar amount (probably the former). In any event, the 50% collateral rule only applies "immediately after the origination of each participant loan . . . " (DOL Reg. Section 2550.408b-1(f)(2)(ii)), and need not be met at all times subsequent to loan origination.

[Guest dms9999]

I have a participant who currently has 2 outstanding loans and the plan does not allow for a third nor would he qualify if the plan did allow. He does qualify for a hardship and his "need" exceeds the balance in his account. He has also deferred more than is currently in his account so he would in theroy be able to take 100% of his account balance. I wasn't able to find anything in the plan document addressing this issue but it seems odd to me that he could wipe his account out yet still have 2 outstanding loans. Would we also have to consider the loans as defaulted or could he continue to repay them? And can he really take 100% of his account balance since then there would be nothing securing the 2 outstanding loans??? (The trustee doesn't want to get into using outside assets to secure the loan). Thx

The 50% security can be determined immediately following the loan. Unless there is something contrary to this in the Loan Policy or Plan Document he can take everything.

There is no difference from the scenario where a participant takes a $5,000 loan when his balance was $10,000 and his balance drops to $7,000 in 6 months. It is not currently secured adequately but it was at the time of the loan.

[jane123]

I agree with dms.

Sieve, would you agree that the option to treat the loan as a deemed distribution satisfies the requirements of 2550.408b-1(f)(1)?

[Guest Sieve]

No. You still must have security of some sort.

If you read -1(f) over & over, like I just did, you'll probably conclude that the concept of security doesn't really mean much if the plan documents provide that a loan is a directed investment of the participant taking the loan. Upon default, there could be (but no doubt would not be) the sale of the security and replacement of the loan with the proceeds--although I've never heard of that happening. So, I see the concept of security as of no use/value in that instance, notwithstanding that the regs require it.

However, if the loan is not a directed investment, but is a general investment of the Plan held proportionately by all participants--and plenty of plans are still like that--then the concept of security takes on a new meaning, and protection of the investment of other participants mandates that there be security of sufficient "value and liquidity that loss of principal or interest will not result . . ." (Reg. -1(f)(1).) So, there must be security in that case so that, aside from treating the default as a deemed distribution for the borrower, the lender (the Trustee, on behalf of all participants) will be able to get its P & I back. A deemed distribution alone cannot make the Trustee (i.e., the participants) whole.

On the obvious side, of course, the regs require that there be adequate security. The account balance can be that adequate security. The ability to treat a loan default as a deemed distribution is not enough. The DOL will treat any participant loan not meeting -1(f) as a prohibited transaction.

[SMB]

I want to re-open this discussion in light of a similar situation I am facing, as well as another "take" on the adequate security issue.

A participant has already taken a loan (current loan balance $40,000) and has additional non-loan investments of $100,000 (i.e., total account balance of $140,000). Investments are participant-directed. The participant qualifies for a hardship distribution, where the documented "financial need" actually exceeds his current non-loan balance.

"The ERISA Outline Book" would seem to indicate that subsequent distributions from a participant's account would NOT affect the adequate security (i.e., loan not to exceed 50% of vested balance) requirement, as long as that requirement was met at the time the loan was made, such that this participant could receive the entire remaining balance of his account in the form of a hardship distribution, leaving the loan as the only account asset (plus future loan payments and contributions).

Yes? No? Maybe?

[Guest Sieve]

I would agree with you. Note that, in most instances, loans from plans must be taken prior to taking a hardship distribution, so this situation probably arises often and the regs do not indicate that it's not permissible.

[masteff]

so this situation probably arises often

In my eight years as a plan administrator with 3-5 hardships per month, I can state for fact that it arises often and that it is absolutely not a problem.

We have to be careful when we say "the need exceeds the non-loan balance"... what we really need to be saying is "the need exceeds the funds available for a hardship and/or in-service withdrawal". This is because many plans have separate rules for pre-tax deferrals vs other monies (especially company contributions, eg safeharbor plans).