IRS Phone forum

[John Feldt ERPA CPC QPA]

I heard (second hand) that in the IRS phone forum this week, the IRS would look unfavorably upon any participant loan interest rate that is less than Prime plus 2 percent, and that they also stated that a participant loan interest rate of "Prime" is totally out of the question.

Well, I thought this was a DOL matter anyway. Also, if I went to a lending institution and put my money in an account there and then asked them what interest rate they would charge me to loan my own account back to myself, wouldn't these firms just say "it's your own account, what rate do you want charge to yourself?" (after first thinking that I must be crazy). Please, tell me if there is a commercially available interest rate to compare against for that type of lending.

Did anyone hear this phone forum from earlier this week, and can you confirm/deny the statement above?

[K2retire]

I didn't hear the recent comment. But I've heard the exact thing you described as their position for at least the last 10 years.

[movedon]

I don't understand how the IRS could take such an arbitrary position. Prime, or less, could be a perfectly reasonable market rate for a secured, five-year, $50,000 loan. I look at local five-year new car loan rates for ideas about reasonable rates, and I see rates from reputable lenders as low as prime minus one. I'd defend that with a straight face.

[Bird]

Correction; this agent said they consider it to be reasonable; not that something else is unreasonable. I do not believe she said that prime is out of the question; I've seen two reports, one is below.

I agree that prime, prime +1 or even prime -1 could be reasonable; we'll continue to use prime plus 1 with no worries in most cases. I did just discuss this with a client with a pooled account, and I think in that case something higher, maybe even more than prime plus 2, could be ok, because making plan loans is taking money away from other investment opportunities and potentially harming other participants if the rate is too low.

Reasonable' Interest Rate for Plan Loans

Is Prime Plus 2 Percent, IRS's Wack Says

By Florence Olsen

Revenue agents will view “prime plus 2 percent” as a reasonable interest rate for loans to participants from qualified retirement plans under tax code Section 72(p), an Internal Revenue Service agent said Sept. 12 during an IRS phone forum.

Kathleen Wack, IRS employee plans revenue agent, referred plan administrators to a government website, at http://www.federalreserve.gov/releases/h15, as the source of daily prime interest rates used by IRS revenue agents.

“We normally add 2 percent” to those rates, Wack said.

Prohibited Transaction Exemption

If a plan makes a loan to a disqualified person, as defined under tax code Section 4975(e)(2), generally the participant loan would be a prohibited transaction under Section 4975©(1) and subject to an excise tax penalty, Wack said.

However, IRS regulations provide a prohibited transaction exemption for loans made to disqualified persons at a reasonable interest rate if similar loans are available to all participants and beneficiaries “on a reasonably equivalent basis,” Wack said.

The prime interest rate is the rate that banks offer their very best customers, but it is rarely used, Wack said. “For this reason, the service generally considers prime plus 2 percent a reasonable interest rate for participant loans,” she said.

Wack added a disclaimer, saying that her comments during the forum should not be relied on as official guidance.

Excise Tax Calculations

All IRS revenue agents in the Employee Plans Division rely on the Federal Reserve website to update the computer programs they use to calculate excise taxes on Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, Wack said.

Wack gave that answer to a question about how IRS would view an investment platform provider that automatically set up loans at “prime plus 1 percent,” without checking to see what the plan administrator considered to be a reasonable market interest rate.

Separately, David Boyd, manager of IRS employee plans mandatory review, said during the forum that the prime plus 2 percent rate is “not etched in stone.”

The question for plan administrators to ask is whether the participant could get a loan in the open market for less than prime plus 2 percent, Boyd said.

“If the answer is no, then I think prime plus two is reasonable,” he said. “It's a general guideline that we go by here at the service.”

[Kevin C]

I listened to that forum. They usually make the transcript available at some point after the presentation. It is not on their site yet.

The speaker said they consider prime + 2% to be a reasonable rate. That doesn't mean something less is not reasonable, just that you may need to justify that a different rate is reasonable.

[ESOP Guy]

My understanding from a John Hancock webinar discussion of this is closer to Bird's understanding. They were expressing an opinion the prime + 2 was reasonable. It does not follow by logic anything else is unreasonable.

To answer J4FKB's questions here is a local credit union website.

You will note they will loan you money secured by a share account at account rate +2%. Their accounts are paying <1% currently. So you could get these people to loan you a secured loan at less than prime at this point.

http://www.firstcommunity.com/rates/loan.html

As far as I can tell the only reason you would take this loan is because you need the money now and don't want to "break" a CD and pay the penalty.