Participant loans from Roth, 401(a)(4) testing, and PT issues

[Belgarath]

I'm seeing a lot of plans that preclude in-service withdrawals or loans from Roth accounts, but allow them from pre-tax deferrals. I'm wondering what y'all think about this. All opinions appreciated!

First, the in-service withdrawal is an "optional form of benefit and the loan is a "right or feature." Purely from the standpoint of nondiscrimination testing, do you believe:

A. That nondiscrimination testing is required, because of the Roth restriction, or,

B. That nondiscrimination testing (in the absence of other restrictions) will pass since the decision to defer on a pre-tax or Roth basis rests solely with the participant, and if loans/withdrawals are important to them, they have an unfettered right to do pre-tax deferrals, and this would therefore satisfy both current and effective availability? (And I recognize that effective availability is subjective at best.)

C. Or, some other opinion?

Second, with regard to Prohibited Transaction issues with the DOL regulations under 2550.408b, since loans must be available on a "reasonably equivalent" basis, I think the same general thought process applies. Do you believe:

A. The lack of availability from Roth accounts makes the plan fail the "reasonably equivalent" test, and thus Prohibited Transactions become an issue, or

B. As in B above, due to the fact that participants CHOOSE pre-tax or Roth, that this satisfies the "reasonably equivalent" requirement?

C. Or, some other opinion?

[Tom Poje]

hadn't thought about that scenario.

arguably, you pass current availability because the person could still take a loan if he had $ in a non Roth account.

(I wouldn't think that is any different than a participant who has no balance (unless you want to argue minimum loan requirement)

so maybe it would boil down to Effective availability and facts and circumstances. Up front, one should know you can't get a loan from Roth, so effectively a Roth choice is an investment that is known to be unavailable for loans. so probably would pass the smell test? e.g. If I had a deferral investment choice that guaranteed 6% return each year, but I couldn't touch it, I think I would forsake any possibility of a loan, but then what do I know?

[Belgarath]

Thanks Tom. Any thoughts on the DOL PT issue?

After letting all this percolate overnight, I feel like a pretty reasonable argument can be made for the "B" interpretations, although I'd feel much more comfortable (being of a generally conservative nature on such issues) if there were no restrictions on Roth accounts that are different than on the non-Roth.

I do believe that some of these restrictions come from funding companies, rather than the TPA's/employers. I know that at least one of them won't allow participant loans from Roth accounts, and I believe that, at least earlier when Roth accounts were "newer" that some wouldn't allow it due to accounting/basis tracking problems.

[K2retire]

I do believe that some of these restrictions come from funding companies, rather than the TPA's/employers. I know that at least one of them won't allow participant loans from Roth accounts, and I believe that, at least earlier when Roth accounts were "newer" that some wouldn't allow it due to accounting/basis tracking problems.

I used to work for one of the record keepers who had exactly that issue. While there, I wrote hundreds of documents that included Roth contributions to exclude the Roth balances from in-service distributions and loans. It never occurred to us that there might be a testing issue and to my knowledge it has never been questioned by an auditor. Although I'd love to hear if anyone else has had the issue raised.

Keep in mind that just because someone can't take a loan from Roth doesn't mean that they can't take a loan, unless ALL their money is in Roth. The Roth balance can still be counted towards the 50% of the account balance that stays in the account.

[Belgarath]

Another wrinkle which occurred to me. While I think the "B" interpretation is generally reasonable for plans that are set up this way originally, I'm not so sure that there are no potential problems if added by amendment. Consider the following:

A plan is set up initially to allow both Roth and pre-tax deferrals. The plan does NOT allow loans or in-service withdrawals. Many participants choose to defer 100% to Roth, while others do pre-tax. Several years later, the plan is amended to allow loans and in-service withdrawals, but NOT from Roth accounts. This, I think, can potentially be a problem.

Any opinions?

I wish I'd never thought of this...

[Kevin C]

The only restriction our VS document has regarding limitations of loan availability to specific sources is that the source limitation must apply consistently to all participants.

On another note, do any of the plans that limit in-service distributions to non-Roth accounts allow in-Plan Roth conversions? I'm wondering if there would be 411(d)(6) issues with a plan that removed the availability of in-service distributions for part of someone's account because of a conversion of amounts not currently available for distribution. None of our clients had any interest in Roth conversions, so we don't have any plans that allow them.