Second 401K Loan Question

[Guest stancel]

Hello ladies and gentlemen. I spent some time reading through lots of post and haven't been able to puzzle out exactly how second 401K loans are calculated. Instead of providing a hypothetical, I will just post my question with real numbers.

Our 401K has horrible investment options, so I take loans and invest my money elsewhere.

My available vested balance is currently $13200. I have one loan, which was taken out in January of 2011 for $5500, and has an outstanding balance of $4150. I took out a second loan in October of 2011 for $3200, with an outstanding balance of $2650.

If I pay off the second loan that has a balance of $2650 (giving me a vested balance of $15850), and then take out another loan, what would the maximum amount be that I could take?

Our company allows for 2 loans with no time requirements between them, and the only restrictions are those imposed by the IRS. I have asked my HR manager, and called the company that manages our 401K. Neither were able to answer my question. They told me I would just have to pay off the second loan, then apply for a new one online and let the computer figure it out. The IRS website wasn't much help either.

I am confused as to whether I would take 50% of $15850 giving me $7925, THEN deduct the outstanding balance from the first loan ($4150) giving me a loan of $3775. Or if I deduct the $4150 from $15850 first, then take 50% of that, giving me a loan of $5850.

Thank You

[BG5150]

Assuming the vested account balance you list does not include the loan, here are my calculations:

Account Balance: 15,850 (after loan is paid off)

Outstanding loan: 4,150

Total Balance: 20,000

50% of total account balance: 10,000

Minus outstanding loan: 10,000 - 4,150 = 5,850

Available loan: 5,850

Some providers consider the loan when they give your balance. Be sure you are using the right numbers.

[ETA Consulting LLC]

$15,850 plus $4,150 = $20,000

50% of $20,000 = $10,000

$10,000 minus $4,150 = $5,850.

I get $5,850.

Good Luck!

[Guest stancel]

Got it!!

Thanks for the responses. That is what I was coming up with, but when my HR manager got that confused look on his face when posed with the question I started questioning myself. It was all down hill from there.

[Bill Presson]

Got it!!

Thanks for the responses. That is what I was coming up with, but when my HR manager got that confused look on his face when posed with the question I started questioning myself. It was all down hill from there.

That's why we prefer to answer things online. You can't see our confused looks!

[Guest cwking891]

The previous answers provided the correct answer by an incredibly fantastic coincidence, but they do not follow the actual procedures for the IRS Regulations which are stated here, and will not work in any other case except with your exact numbers!

• Statutory maximum
  All of a participant’s loans from a plan are limited to the lesser of:
  1. $50,000, reduced by:
     • the highest outstanding balance of loans during the 12 months ending the day before the new loan, minus
     • the outstanding balance of loans on the day of the new loan; or
       
  2. the greater of:
     • one-half the participant’s vested plan account balance (the present value of the participant’s vested accrued benefit for defined benefit plans),
     • or $10,000.

You originallly had two loans, on 1/2011 and 7/2011, and you are taking the new loan on 6/2012. Then you need to look at your payment schedule to come up with the highest open balance (HOB) of the two loans in the period 6/2011 to the day before you take your new loan. You have not provided that info here, but it can be estimated.

Your loan1 of $5500 is reduced to its current balance of $4150 by paying $1350, or about $80/month for the 17 months from 1/2011 to 6/2012. The max balance of loan2 will occur on 7/2011 and be $3200. At that time, the loan1 bal would be about $5500 - 6*$80 or $5020, so your highest open balance would be $8220.

You pay off loan2 and end up with vested balance of $15850.

Now apply the statutory rules:

Lesser of:

1. $50000 - ($8220 - $4150) = $45930

2. Greater of 1/2 of $15850:$7925 vs $10000 => $10000

The total of all of your loans is limited to $10000, because of the statutory rules, and because you have less than $91,860 invested, your payment schedule and condition 1 above becomes irrelevant.

$10000 - $4150 = $5850.

You may borrow $5850.

This is a strict mathematical and logical interpretation of the IRS rules.

[ETA Consulting LLC]

Well, we determined by looking that the $50,000 reduced by the highest outstanding loan balance wasn't a consideration; and solved for the relevant calculation. It wasn't a coincidence, just a quicker way by immediately focusing on the relevant equation.

Good Luck!

[K2retire]

Although some plans have a $10,000 limit, that is not a requirement.

[masteff]

1) Be careful of the date of the posts when reading threads. This thread was 18 months old prior to today's posts.

one-half the participant’s vested plan account balance (the present value of the participant’s vested accrued benefit for defined benefit plans),

Greater of 1/2 of $15850:$7925 vs $10000 => $10000

2) Your logical flaw is that the participant's vested plan account balance should include the participant's outstanding loan balance. It is an asset of the account. Note the warning in the last line of post #2 above. From the original post, we can deduce that the outstanding loan of $4150 is not included in the stated balance of $15850, therefore it must be added back before completing the calc. The math in posts # 2 and 3 is correct.

[Guest cwking891]

Thank you for the useful comments. They are helpful regardless of the age of the original post, to help google searchers who are researching the rules.

Once commenter mentioned that not all plans have the $10,000 threshold, but it should be considered as the standard because it is written into the basic IRS regulations, and will be there unless specifically omitted by your individual plan rules.

Another commenter pointed out that the vested account balance (i.e. non-forfeitable account benefit) should include the outstanding balance of existing loans. Thank you for pointing that out. While not explicitly mentioned in IRS rules for computing vested account balance, it is logical. Assume that the 401K had to be re-assigned. All loans would become due, and therefore the loan balance would be included in plan balance.

Yes, in this case, you can quickly see that the $50,000 threshhold will not come into play and avoid the math of computing the Highest Outstanding Balance of any loans in the 12-month period ending the day before the new loan.

Finally, the incredible coincidence does still exist because 1/2 of the plan balance of $15850 plus outstanding loan balance of $4150 is exactly $10,000, matching the lower threshold of $10,000.

Suppose the plan balance was $12,850. In this case .5*(12850+4150) is $8500, so the $10000 threshold is used, giving an available loan of $10,000 - $4150 = $5850.

But if the plan balance was $18,850 then the available loan is .5*(18850+4150) - 4150 = $7,350.

The commenters obviously have experience in doing these calculation, whereas I am designing a computer program for the first time to do the calculations and therefore had to create an exact rigorous algorithm.

What I learned from this analysis is to be sure to examine the $10,000 lower threshold for applicability, unless it is specifically excluded from the employer plan, and to include current loan balance in the vested account balance.

Thank you for providing your expertise.

[ETA Consulting LLC]

In your computer program, you'd include a question: "does the $10,000 minimum apply". You would then include the contingent calculation if the answer is yes. It's a simple work around; but a question that would be asked.

Good Luck!

[Guest cwking891]

Thanks greatly, ERISAtoolkit.

I wrote the program and thought it was perfected, but I ran a test tonight that did not make sense. Can you provide some insight. It is related to the Second 401K Loan issue and expands it to include a Third loan.

Here are the specifics:

Taking a loan on 3/1/2014:

401K Balance: $150,000

Loan Balance: $29,000

High Loan balance in 12 month period 3/1/2013 to 2/28/2014: $40,200.

According to my algorithm, I would use:

$50,000, reduced by:

• the highest outstanding balance of loans during the 12 months ending the day before the new loan, minus
• the outstanding balance of loans on the day of the new loan

This gives $50,000 - ($40,200 - $29,000) = $38,800 = max of all loans.

So I could borrow $38,800 - $29,000 = $9,800.

But, then, look at my numbers just one month later, on 4/1/2014:

401K Balance: $153,000 (increased by growth and earlier loan payment)

Loan Balance: $35,750 (the $29,000 increased by new loan of $9,800 minus earlier loan pmt)

High Loan Balance in period 4/1/2013 to 3/31/2014 is still $40,200.

According to this, I could borrow on 4/1/2014:

$50,000 - ($40,200 - $35,750) = $45,550 = max of all loans

So I could borrow $45,550 - $35,750 = $9800.

Why can I still borrow another $9,800 just one month after I took a $9,800 loan.

Am i correct or am I missing some concept or doing the math wrong?

Thanks for your expertise.

Chris

[ETA Consulting LLC]

I see what you are saying: the regs do not apply a cumulative effect on loans. I can borrow $25,000 today and pay it off tomorrow. I can, then, borrow another $25,000 and pay it off the day after than. I can, then, borrow (yet another) $25,000 and choose not to pay it off. The following day, I could borrow another $25,000 (which would take my loan balance up to $50,000).

Why? Because at no point in time did the outstanding loan balance ever exceed $25,000. The net effect would be that I actually borrowed $100,000 in new loans; but the transactions were structured in a way that my outstanding loans never exceeded $25,000 (because I paid them off in order to prevent the new loan from being added to the oustanding balance).

Your program would appear correct once you take this into account. Also remember that you must treat all plans of the employer as a single plan for this purpose. You cannot take a $50,000 loan from one plan and then turn around and take a $50,000 loan from another plan of the same employer. I know two plans for employers are not common, but this is be added as a footnote.

Good Luck!

[Guest cwking891]

In the example I gave the max loan on 3/1/2014 was $9800. One month later I had made total loan payments of $3050 but could still take out a brand new loan of $9800.

Since this does not seem logical I am continuing to research the algorithm I used to look for any mistakes. I have also sent an inquiry using this example to the Retirement customer service department at E*Trade.

[ETA Consulting LLC]

It is logical:

1) Since your vested balance exceeds $100k, your loan limit will be calculated using $50,000 reduced by the highest outstanding loan balance (on any day) during the last year.

2) When this is the case, you can ALWAYS borrow additional amounts UNTIL you actually have an outstanding loan balance of $50,000.

You can borrow $1 million from the plan by consistently borrowing $25,000 and paying it off the following day; and borrowing another $25,000 the next day. You can repeat this cycle because at no point in time will your loan balance exceed $25,000.

Good Luck!

[BG5150]

A quick explanation of the $10,000 limit from 72(p) from the ERISA Outline Book:

Quote

1.a. $10,000 minimum provides exception to 50% rule. A loan up to $10,000 is not taxable, even if the amount exceeds 50% of the participant's vested accrued benefit. IRC §72(p)(2)(A)(ii). However, under DOL Reg. §2550.408b-1(f), a loan may not be secured by more than 50% of the vested accrued benefit. This limit on the security interest is a condition of the prohibited transaction exemption available for the loan under IRC §4975(d)(1) and ERISA §408(b)(1) (discussed in Chapter 14, Section II, Part B.2). If a plan will make a loan that exceeds 50% of the vested accrued benefit under this $10,000 minimum rule, additional collateral will be required to satisfy the prohibited transaction exemption.

$10,000 rule might avoid adverse tax consequences for inadvertent excess loans. Although a plan usually won’t permit loans in excess of 50% of the vested benefit, the $10,000 minimum rule may come in handy where an administrative error results in more than 50% being lent to the participant.  Although the plan will need to take corrective steps if the amount in excess of 50% violates the plan’s terms, at least the excess will not automatically cause a deemed distribution under §72(p) if the loan amount does not exceed $10,000.

[sheadan@aol.com]

just out of curiosity can an employee have 50,000.00 loans each from 2 different employers?

[Belgarath]

Yes, with the caveat that for these purposes, related employers that are part of the same controlled group or affiliated services group under IRC 414 are treated as a single employer.

[hr for me]

And with the caveat that if one is a former employer, they may or may not allow terminated employees to take a loan from any 401k balance left in the plan or to continue loan payments after they are terminated.