1.401(k)-1(d)(3)(iv)(D)/Hardship- Employee Need not take counterproductive acts

[Guest 401kizzle]

I know the reg gives the example regarding a primary residence hardship and the loan causing the inability to get 3rd party financing for a mortgage for the residence, but should this be interpreted to say a loan should not be required if it would cause further hardship. Basically, if the person can't get 3rd party financing how would increasing their debt help them.

[masteff]

but should this be interpreted to say a loan should not be required if it would cause further hardship.

Your word "interpreted" is unneeded because the reg explicitly says "a need cannot reasonably be relieved by one of the actions described in paragraph (d)(3)(iv)© of this section if the effect would be to increase the amount of the need" (emphasis added). So yes, if taking a loan would increase the hardship need, then the loan would be counterproductive and not required. But in my experience, use of the "counterproductive action" exception is rare; the minimum plan loan of $1000 is only $15-20/month; incurring monthly payments is not a hardship by itself unless they can show it would put them into negative cashflow or violate a debt-to-income requirement.

Keep in mind the reg addresses all "actions described in paragraph (d)(3)(iv)©", not just loans. Another example is if, per (d)(3)(iv)©(2), an employee had a CD or whole life insurance with an early withdrawal penalty, then forfeiting interest already earned might be considered a counterproductive action.

Further, someone once suggested that in the sale of personal assets which would result in taxes (esp such as capital gains taxes), incurring taxes would be a counterproductive action because the person's need is then increased by the additional tax owed. (I disagree because it ignores the net effect but you can see the logic; in favor of the argument is that (d)(3)(iv)©(4) distinguishes taxable vs nontaxable loans.)

[GMK]

Out of curiosity

Do banks view a loan from a plan as an increase in debt or a reduction in assets? For example, loan payments would be considered in monthly cash flow, but unlike a loan from a 3rd party, the borrower's obligation for failing to make the payments is only the tax on the deemed distribution, yes? Point being that the tax may be substantial, but it is much less than the amount borrowed.

Do the firms who calculate credit rating scores take into account a loan from a plan?

We don't do plan loans (philosophical and administrative reasons), so for me these are just academic questions. If anyone has the time to answer, thanks.