Are Loan Offsets Mandatory

[Briandfox]

If a participant elects to have an in service distribution when there is an outstanding loan to the participant is it mandatory that the in service distribution trigger an offset for the amounts of the outstanding loan receivable?

Situation is as follows, say a participant has a 50k loan outstanding from the plan and a non-loan balance of 50k. The participant is eligible for an in service distribution and wants to take an in service distribution of the 50k and roll it over to an IRA.

For whatever reason, he wants to retain the loan balance in his account and wants to make repayments, as in he does not want to treat this as a loan offset.

Is that ok?

Is there anything in the code or regs. that makes a loan offset mandatory in these circumstances? All, I can see is that the terms of the plan document and promissory note govern.

What if both are slient?

[Lou S.]

I am not aware of anything that would require an offset.

It is possible the plan document or plan loan program may require it but I have not seen that the case.

The "classic" example is in the case of a loan followed by a hardship distribution where after the hardship distribution the participant's balanace may consist solely of the loan balance.

[Briandfox]

In that situation is the hardship distribution not offset against the remaining balance of the loan?

[Lou S.]

Typically, no it is not.

[ESOP Guy]

Just to be clear the loan is current correct? It is not in default correct?

[Briandfox]

Yep, the loan isn't in default, it is current. I think I know where you are going with this (loan offset is triggered on default if the plan has in service distributions?).

[Lou S.]

I'm still not sure why you would offset it unless he requests it as a taxable distribution.

[Briandfox]

Aren't loan offsets eligible for rollover?

[Lou S.]

Sure, if you have the cash. But if that was the case he'd probably just pay off the loan and then do the rollover.

[Briandfox]

Follow up question, if a participant is current on a loan and the plan allows for in service distributions, can a participant take an in service distribution of their total account balance even though the loan is outstanding?

I think they can and their account balance is not collateral or security for the loan but for some reason it rubs my boss the wrong way because a participant is generally limited to taking 50% of their vested account balance when they take a loan. He thinks the account balance is security for the loan.

I don't.

[K2retire]

Many record keepers agree with your boss. As far as I know, the rule is that the 50% balance must be in the account on the day the loan is issued, not for the life of the loan.

[RatherBeGolfing]

Follow up question, if a participant is current on a loan and the plan allows for in service distributions, can a participant take an in service distribution of their total account balance even though the loan is outstanding?

I think they can and their account balance is not collateral or security for the loan but for some reason it rubs my boss the wrong way because a participant is generally limited to taking 50% of their vested account balance when they take a loan. He thinks the account balance is security for the loan.

I don't.

You are correct. If otherwise eligible, a participant can withdraw his/her remaining account balance. The 50% is used when calculating the available loan, but does not have to remain in the account after the loan has been issued.

J

[Briandfox]

If 50% of the vested account balance is used to secure the loan, shouldn't that portion of the account balance be frozen during the life of the loan?

[RatherBeGolfing]

If 50% of the vested account balance is used to secure the loan, shouldn't that portion of the account balance be frozen during the life of the loan?

The assets in the account are not actually security in that sense. The 50% comes in to play only for calculating and issuing the loan. The loan is considered adequately secured when issued, subsequent changes to the account balance does not change that.

From the ERISA Outline Book / Chapter 7

The 50% limit is not affected by distributions taken by the participant after the date of the loan, even if the outstanding loan balance exceeds 50% of the value of the vested accrued benefit that remains after the distribution. This situation arises in particular with hardship withdrawals from 401(k) plans because many plans require the maximum available loans to be taken before any hardship withdrawals are available.

4.c.1) Example. Mya needs $15,000 for her son's college expenses. Her employer's 401(k) plan permits hardship withdrawals for this purpose. One condition for taking a hardship withdrawal is that she first take the maximum loans available from the plan. Mya's vested account balance is $22,000. The plan permits loans up to 50% of the vested account balance. Mya borrows $11,000 and then requests a hardship withdrawal for $4,000 to cover the remaining college expenses. Immediately after the hardship withdrawal, her vested account is only $18,000, $11,000 attributable to the outstanding loan and $7,000 attributable to other investments. Although the outstanding loan balance equals 61% of her vested account immediately after the distribution, the 50% loan limit is not exceeded because at the time of the loan the 50% limit was satisfied.

[Briandfox]

Thanks, good cite.