Participant loan has to be less than 50% of vested balance?

[Guest Lin]

Normally a lot of plans will specify this limit (loan<50% of vested balance) in the plan document, but not this one.

Is the 50% rule a general one? If so, where can I find the official reference?

Thanks!

[J Simmons]

Normally a lot of plans will specify this limit (loan<50% of vested balance) in the plan document, but not this one.

Is the 50% rule a general one? If so, where can I find the official reference?

Thanks!

the greater of 1/2 of vested accrued benefit or $10,000. Here is the Code 72p2Aii and Reg 1.72p-1

[Guest Sieve]

Technically, the plan could allow more than 50% to be taken as a loan even if the loan exeeds $10,000, but the excess amount would be treated as income to the borrower. Of course, the document would have to permit such a loan, and few do. Also, additional security (other than the plan account) is required any time the loan exceeds 50%, and few plans want to mess with that.

The result, therefore, is that hardly any few plans permit loans exceeding 50% of the vested account balance.

[Kathy]

If the plan allows a loan in excess of the 72(p) rules wouldn't that be 1. a prohibited transaction subject to an excise tax which can go up to 100%? and 2. could it be construed as a distribuiton without a distributable event and therefore disqualifiy the plan? I can't imagine a plan not including the language limiting the loan, at least by reference. An interesting idea.

[Laura Harrington]

If the plan allows a loan in excess of the 72(p) rules wouldn't that be 1. a prohibited transaction subject to an excise tax which can go up to 100%? and 2. could it be construed as a distribuiton without a distributable event and therefore disqualifiy the plan? I can't imagine a plan not including the language limiting the loan, at least by reference. An interesting idea.

The rules under 72(p) are for determining whether or not the loan is a taxable distribution. These rules are separate from the prohibited transaction rules.

Under 72(p), if the loan exceeds 50% of the vested account balance the excess is a taxable distribution.

In order for the loan to not be a prohibited transaction, no more than 50% of the vested account balance can be used as collateral.

Therefore, allowing a loan in excess of 50% of the vested account balance does not create a prohibited transaction assuming additional collateral was obtained. The plan loan program should outline what can be accepted as additional collateral.

[Guest Sieve]

A loan which exceeds the IRC Section 72(p) dollar limitations (or any other IRC Section 72(p) conditions) is not a distribution. It is a deemed distribution. (Treas. Reg. Section 1.72(p)-1, Q&A-3 & Q&A-4.) Otherwise, a defaulted loan (not repaid within 5 years), if treated as a distribution, would disqualify a 401(k) plan, and the regs specifically indicate that disqualification does not result from a deemed distribution. (Treas. Reg. Section 1.72(p)-1, Q&A-12.)

A violation of IRC Section 72(p) is not inherently a PT. A loan is only a PT if the loan does not meet the requirements of IRC Section 4975(d)(1) or ERISA Section 408(b)(1), independently of IRC Section 72(p) requirements--e.g., if loans exceeding $50,000 (or any other amount, for that matter) are awarded only to HCEs and therefore are not "available . . . on a reasonably equivalent basis" and are "made available to [HCEs] in an amount greater than the amount made available [to NHCEs]". The PT rules have no direct tie-in to IRC Section 72(p).

(I see Laura got in just before me with some of these same points.)

[J Simmons]

In practice, do you see such loan programs--exceeding the 72p limits and thus being deemed distributions (taxable), but not PTs--being used as a ruse to evade otherwise applicable prohibitions on in-service distributions? That is, are the plan trusts being repaid the excess? Are the plan administrators/trustees pursuing those that do not repay the excess, such as by foreclosing on the collateral?

[Guest Sieve]

Personally, I've never seen a plan that permits loans in excess of the 72(p) limits. And giving such loans when the plan does not permit them would be a fiduciary breach (not following plan terms).

Of course, the in-service distribution ruse can be played no matter the amount of the loan. But, if there is a mandatory payroll deduction provision in the plan and in the loan documents signed by the borrower, then there is no ruse to play if the full amount of the loan (even those amounts exceeding 50%) is properly amortized, because the full amount is being repaid AND there is a deemed distribution.

[J Simmons]

Personally, I've never seen a plan that permits loans in excess of the 72(p) limits.

Me neither. But nor have I seen the Loch Ness monster, but hypothetically I guess its possible.