Can a Plan Have These Types of Loans?

[mming]

An employee (neither an owner, officer or relative of one) borrows money from the company 401k plan shortly before he is eligible to partipate. Is this construed to be a participant loan once the employee enters the plan? No payments or accrued interest have ever been shown on the loan, which I suppose could be acceptable if the loan is considered to be just a third-party loan that's structured as a balloon note.

This same employee evidently has another loan that is owned by the owner's personal IRA. This IRA is currently being rolled over into the plan mentioned above. It does not appear that this would be a prohibited transaction since the employee isn't a party in interest - would this transaction be legally acceptable? All help is greatly appreciated.

[rcline46]

Unless the loans were structured by an ERISA attorney, they are in a HEAP of trouble.

Loan from 401(k) - this would have to be a balance forward plan, and the investment policy would have to permit 3Rd party loans, and it would have to be prudent investment. My best guess is that the loan does not fit in all three categories.

Loan for IRA - it seems that the owner of the company loaned money from the owners IRA to a third party. An IRA, to my knowledge, cannot do loans except in some really oddball situations. If you mean the soon to be employee borrowed from his own IRA, no can do - it is a distribution from the IRA, and may even have disqualified the entire IRA.

Don't know where you find these people, but they need to have very good legal representation because they are playing with fire while standing in gasoline.

[mming]

Thank you for the quick reply. The plan's investment policy does allow for 3rd party loans and, knowing the owner, he can justify the loan's prudence and produce collateral. Can it be considered a valid 3rd party loan even after the employee enters the plan since, technically, the plan did not lend money to a participant - or must it be now considered a participant loan? Not sure of the balance forward reference - I'm not familiar with that type of plan - this one is a traditional 401k which can have either/both participant and 3rd party loans.

For the IRA loan, it is definitely the owner's IRA holding a loan to an employee who later became a 401k participant. I should clarify that either the IRA made the loan directly to the employee or the IRA acquired an existing debt that the employee had. The IRA is being held by a company who's known for holding assets that most IRA custodians wouldn't (or couldn't) normally hold, so I'm not surprised to see a note in one of their IRAs - perhaps this is one of those oddball situations. The owner's IRA, which owns a loan to an employee who is now also a participant in the plan, is being rolled over into the plan - sounds like it shouldn't pass the smell test but I can't point to any specific rule being violated.

As for where I find these people, I guess I'm just lucky that way - I've been asked that question many times, especially after I've asked a colleague "Have you ever seen this in a plan......"

[movedon]

...the employee isn't a party in interest...

Que?

[Lou S.]

Don't know where you find these people, but they need to have very good legal representation because they are playing with fire while standing in gasoline.

That's awesome. I'm going to have to remember this one.

Agree on all your other points.

[QDROphile]

No agreement on an employee not being a party in interest. ERISA 3(14) (H). An employee is not a disqualified person, without more. IRC 4975(e) (H).