Minimum loan rate

[Cynchbeast]

What is the minimum rate allowable for participant loans?

We normally set at Prime +2%, but at 5.75% this is higher than participants might be able to get elsewhere.

[Lou S.]

Prime + 2 should be 5.25% if I'm not mistaken.

We typically use prime plus 1.

If you take a survey of local banks for secured loan rates I'm pretty sure you can justify a lower rate, just keep documentation to support it.

[shERPA]

IRS was making noise about having to be prime plus two a while back - anyone remember that?

But IMO a plan loan is most comparable to a loan fully secured by a savings account, as there is no risk of loss to the plan or the other participants. Bankate.com suggests that these loans are typically at 3% over the rate paid on the collateral account. I checked my own credit union which offers a loan at 2.5% over the rate paid on the account.

Looking at their savings rates, they range from 0.15% on a 30 day certificate to to 2.18% on a 60 month jumbo CD over $100K. Taking a mid-range rate of 1.64% on a $50K 48 month CD plus 2.5 = 4.14% which is 0.89 over prime. Even taking the highest CD rate of 2.18 plus 2.5% is 1.43% over prime.

I like prime +1 in our loan programs.

[NJ Mike]

We have been using Prime +1%.

[Kevin C]

The IRS mention of prime+ 2% was during a phone forum on 9/12/2011. Here is a link to the transcript and the portion dealing with the issue.

http://www.irs.gov/pub/irs-tege/loans_phoneforum_transcript.pdf

Question three says, “Many of the investment platforms set up a default interest rate based on prime, which is used for all plan loans. I know of one platform that automatically sets loans up at prime plus 1% without checking with the plan administrator to see what interest rate they believe to be current marketable rates. Please address what the IRS views as an acceptable market interest rate and the plans exposure if the investment platform automatically assigns a less than marketable rate to plan loans.

Employee plans uses—and this will be included in the transcript but we would use www.federalreserve.gov/releases/h15 and those give interest rates on a daily basis. We normally add 2%. The answer additionally says, “If the interest rate does not constitute a reasonable interest rate and the loan is made to a disqualified person as defined in IRC 4975(e)(2) then the participant loan would constitute a prohibited transaction under IRC 4975(d)(1) and would be subject to excise tax. The exception for prohibited transactions with respect to loans made to participants or disqualified persons requires the loan bear a reasonable rate of interest. In addition, the prohibited transaction exemption requires that loans be available to all such participants or beneficiaries on a reasonably equivalent basis.

Generally, the prime interest rate is a rate that banks only give to their very best customers and rare, very rare at that. For this reason as a general rule the Service generally considers prime plus 2% as a reasonable interest rate for participant loans, and I hope that helps you. Again, it’s www.federalreserve.gov/releases/h15, and this is used over and over and over again. All of our Internal Revenue agents in employee plans have been given this Web site to update their computer program that they use to calculate excise taxes for Form 5330.

Let’s try to find a shorter question.

D. Boyd: Kathleen, let me say something while you’re looking for other questions. There is nothing in stone as far as this prime plus 2% but that is what we deem to be a reasonable rate. There could be, I guess, an argument that you could make or somehow that you could offer a rate that’s less than prime plus two that would be reasonable but you’d have to make that argument. Could this taxpayer, could this individual, this participant go out and get a loan for less than that in the open market?

I guess that’s a question you need to ask yourself and if the answer is no than I think prime plus two is reasonable. If you can show documentation that participant can go out and get a loan at a lower rate then that’s what you’ll need to be able to prove to the agent that’s out there looking at this particular loan, so just something to kind of keep in mind. Like I said, it’s nothing that’s etched in stone but it is a general guideline that we go by here at the Service.

[ESOP Guy]

I like shERPA's logic. I think he is right. But clearly the IRS doesn't agree with that logic Kevin C's post.

The IRS' problem I think is they don't see the loan as 100% secured. That is why they keep coming up with the silly idea that you can't borrow more then 50% because the remaining amount is needed to secure the rest.

That is nonsense. The loan is self securing. If the borrower defaults the plan writes a 1099-R for the default amount and no one loses anything. A taxable event happens but no one has lost anything. That would be true if you allowed loans for 100% of the person's balance. But the person got their full benefit. Everyone else in the plan would get their full benefit.

It doesn't matter if the plan is a daily valued plan or a balance forward plan. The account of the person taking the loan would fully secure a loan of any amount that is no more then 100% of the person's balance as of the day of the loan being made.

By the way my credit union would loan you for 60 months at CD rate plus 2% a loan that is secured by a 60 month CD you have with them. The CD rate plus 2% comes up to 3.45% barely over prime. I think you ought to be able to run a loan program with that rate but I think the IRS would not take kindly to it.