Minimum Loan Amount

[Guest andmik]

Hello:

Need some help please.

Client has a minimum loan amount in its loan policy of $3000. Although I find nothing in the way of a regulatory/statutory guidance for a "maximum" minimum loan threshold, I have actually never seen a plan impose minimum in excess of $1000.

I am concerned this client is violating a rule, or in the very least an auditor would find that this discriminates in favor of HCEs, but would like to get others' thoughts on how to support my concern, if others believe it is founded.

andmik

[BG5150]

This is from the ERISA Outline Book:

2.a.1)$1,000 minimum loan is permitted. Loans do not fail to be available on a reasonably equivalent basis merely because a minimum loan amount up to $1,000 is required by the plan. §2550.408b-1(b)(2). The minimum loan requirement may be disregarded in determining whether the loans are available on a nondiscriminatory basis. See Treas. Reg. §1.401(a)(4)-4(b)(2)(ii)(E).

[Blackbirch]

This is from the ERISA Outline Book:

2.a.1)$1,000 minimum loan is permitted. Loans do not fail to be available on a reasonably equivalent basis merely because a minimum loan amount up to $1,000 is required by the plan. §2550.408b-1(b)(2). The minimum loan requirement may be disregarded in determining whether the loans are available on a nondiscriminatory basis. See Treas. Reg. §1.401(a)(4)-4(b)(2)(ii)(E).

The way I'm reading the regs, you're not prohibited from having the $3,000 minimum, but the loan will be treated as a BRF that is unavailable for those who cannot afford the minimum.

Long story short, you may want to look at your population to see what portion of your NHCEs have account balances of <$3,000. In doing so, you'll probably want to exclude any contributions that are either (a) unvested or (b) not eligible for loans.

[Guest Sieve]

You are correct that minimum loan amounts over $1,000 have to be analyzed under 401(a)(4).

But, there's a worse problem. A loan minimum over $1,000 may be considered to cause the loan not to be available on a "reasonably equivalent basis", and therefore the loan program would be a prohibited transaction. (DOL Reg. Section 2550.408b-1(b)(2).) This section of the regs does not specifically prohibit loan minimums over $1,000, nor does it cause all such higher loan minimums to be problematic. But, it is generally understood that it is something to be avoided like the plague.

I spoke with the DOL about a similar situation, and was told to be prepared to show, on audit, why the higher limit had not caused there to be a prohibited transaction. I believe that would probably depend, in the OP's case, on how many participants had account balances under $6,000. And, I recommend that the minimum be reduced to $1,000 immediately.

[Blackbirch]

...how many participants had account balances under $6,000.

$6,000?

I'm assuming your thought is that with a 50% restriction, you'd need $6,000 to meet the $3,000 minimum loan requirement? My reading of 72(p)(2)(A)(ii) is that the 50% restriction only applies where the account balance is $20,000 or greater.

Not to be picky, but setting the bar at 3,000 v. 6,000 would likely have a substantial effect on the 401(a)(4) testing.

[austin3515]

If you';re using the $10K de minis rule to get out of the 50%, my understanding is that the Plan needs to obtain security outside the plan to protect it. Really really ugly in my opinion...

[Guest Sieve]

Blackbirch --

Austin is dead on. A plan which uses more than half of the account balance as security for a participant loan is engaging in a prohibited transaction because such a loan is not considerded to be adequately secured". (IRC Sectin 4975(d)(1)(E), ERISA Section 408(b)(1)(E) & DOL Reg. Section 2550.408b-1(b)(f)(2)(i).)

I would not recommend that a Plan start getting into the business of securing plan loans with assets other than Plan assets . . .

[Blackbirch]

Thanks for the discussion, guys. Quick follow-up...

Operationally, what's the point of securing a participant loan?

Assume:

12K account balance

7K loan

You're saying this would require 2K in outside security (excess of 7K loan over 5K remaining account balance). What would be the point? When would that 2k ever be called? In the even of an default, wouldn't you just treat the unpaid balance (assume the full 7K in our case) as a deemed distribution and adjust the account balance to 5K?

(Don't be scared; I'm not administering participant loans!)

[Guest Sieve]

In your hypo, $1,000 (not $2,000) additional security would be needed (excess of loan amount ($7,000) over half of vested account balance ($6,000)).

The point of securing a participant loan is the same as securing any other loan (since the regs really require that the loan be treated as any other comparabole commercial loan would be treated): in the event of default, the Plan has something to go after. But--without looking at the proposed & final regs' preambles--I really don't know why the 50% limitation, unless it was considered not generally a reasonable commercial loan without the security limitation.

[Blackbirch]

The point of securing a participant loan is the same as securing any other loan: in the event of default, the Plan has something to go after.

Still confused. The participant's already made whole. In the process of making the deemed distribution, the participant's individual debt is forgiven, and his account balance is similarly reduced. If the plan went after the additional security, what would they do with the spare $1,000? Restore the account balance (windfall for participant)? Credit it to a suspense account to offset future ER contributions? Host a cocktail party?

I've got the legislative history lying around here somewhere... I was just hoping somebody knew offhand. What can I say? It bugs me when things don't make sense.

Thanks again for your insights/patience.

[Guest Sieve]

You're in the wrong business if everything has to make sense!!

The portion of the account balance represented by the loan is deemed distributed because the account balance is used as security. With no security, would it really be a loan in the first place, or just a distribution? Remember, these loan rules are to prevent the transaction from being a PT (which it otherwise would be), so extra protection is required to make it quack like a loan!

Remember, the law & regs require the treatment described earlier--primarily for PT exemption purpsoes:

• The law requires that there be adequate security or the participant loan is a PT.
  
• Then the regs say that adequate security is, among other things, "something in addition to and supporting a promise to pay", so the loan may not be unsecured.
  
• And, the "adequacy of such security will be determined in light of the type and amount of security which would be required in the case of an otherwise identical transaction in a normal commercial setting between unrelated parties on arm's-length terms." (DOL Reg. Section 2550.408b-1(f)(1).) So, as a commercial loan, the full amount of the cash loan would generally be required to be secured by the "deposit" or by something else equal to the value of the loan.
  
• If secured by the deposit, then no more than half of the deposit can be used.
  

[austin3515]

In my opinion, it is a little silly to require the whole 50% security thing. Someone on these boards once said about a regulations appearent lack of common sense, which I think applies in many situations:

"Surely there was sense involved in the creation of regulations such as these. It's just that those who drafted the regulations are of such an elite caliber that the sense used was not common."

I'm pretty sure it was WDIK, but then again, what do I know... (LOL) It could have been someone else...

[K2retire]

As the child of a clinical psychologist, I have it on good authority that attempting to make sense of IRS regulations will make you certifiably crazy!