401K loan question

[Juan Falso]

I have a brief question concerning 401K loans.  Account has over  well 100,000 in value. Employee takes out loan . Employee takes 12 month leave of absence. At X % the loan amount increases to 49,000. upon his return the employee, on the same day, pays off the balance and takes out a new loan. Seems as though there are two steps:  Determine the allowable amount of loan and Ensure that the loan, upon issuance, does not exceed allowable amount. USING THE FOLLOWING: (i) $50,000, reduced by the excess (if any) of— (I) the highest outstanding balance of loans from the plan during the 1-year period ending on the day before the date on which such loan was made, over (II) the outstanding balance of loans from the plan on the date on which such loan was made, or  (ii) the greater of (I) one-half of the present value of the non-forfeitable accrued benefit of the employee under the plan, or (II) $10,000. 50,000- (49,000-49,000)=50,000 I guess that you could argue that the outstanding balance at any point during the day was either the 49,000 or the new loan amount of 50,000.. but never both.  Or , the 49,000 on the day of the loan plus the 50,000 of the new loan:  50,000-(49,000-99,000)= 100,000, which is then limited to 50,000.  Alternatively, if the loan was paid off the day before, you could argue that upon issuance of the loan the outstanding balance for the day is 50,000   Resulting in 50,000-(49,000-50,000) = 51,000 which is then limited to 50,000. I guess my point is there seems to be no reference as to timing or time of day.  Once issued a loan balance is "outstanding".  So really the limit is that the combined amount is 50k.  As for step two, knowing the first loan is paid, allows for the issuance of the second loan. Let the comments begin.

[Larry Starr]

Huh? The outstanding balance the day before the new loan was $49k. That's the highest outstanding balance in the prior 12 months.  That leaves a maximum of $1,000 that can be borrowed.  I'm not even going to try to figure out your math because it makes my head hurt! :-)

The purpose of the rule is to PREVENT a perpetual loan, which is what you are attempting; that's a Bozo No No!

Larry.

[Mike Preston]

Try this link. Larry, OF COURSE, is correct.  I don't know where the language being cited (as if it is authoritative) comes from.  At the least, I would change "on the date" to "at the moment", if there is a repayment between "the day before the new loan is taken" and "at the moment". But what the OP is trying to justify seems far fetched to me.

http://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Loans#6

See attached spreadsheet which may clarify things.

 

Loan Maximum Calculator.xls

[ESOP Guy]

9 hours ago, Larry Starr said:

 that's a Bozo No No!

Larry.

Is the term "Bozo No No" found in the regulations? 

[Juan Falso]

Source of text cited is:

https://www.gpo.gov/fdsys/pkg/USCODE-2011-title26/pdf/USCODE-2011-title26-subtitleA-chap1-subchapB-partII-sec72.pdf

Perpetual loans would imply never repaying the loan.  In the cited example the loan is repaid in full indicating a certain level of liquidity.

To the extent that you are paying an appropriate interest rate what is the concern? it is like any other investment.  One might argue that this could be a good strategy for earning a better return on cash reserves than say a regular money market acct.

I could use money from the same account to by a mcdonalds franchise, work there and never pay it off.  So is the intent really to stop one from perpetual use of the funds or is this just a long confusing way to say that your combined loans cant exceed $50,000?

[Mike Preston]

I'd say that citing the Code is fairly authoritative (although we have all seen cases where the IRS issues regulations that tries to override what the Code says).

But I still don't buy it.

[ESOP Guy]

The problem isn't his cite it is his math or maybe his understanding of the words in the Code. 

When you write this you are wrong: 50,000- (49,000-49,000)=50,000

The amount of current outstanding loan the moment before the new loan (and moment is a better word to understand what the IRS is means when the say day) is $0

So the math goes like this:  50,000-(49,000-0)=1,000.

Look at the IRS example in the link provided by Mike P.

If you don't like how the IRS is using the words " the outstanding balance of loans from the plan on the date on which such loan was made, " take them to court and good luck. 

But what they have consistently said in examples, regulations and so forth is the balance the moment before the new loan is issued is what those words mean. . 

[ESOP Guy]

I would add if you look at the example Mike P links to one of the quirks of these rules is you are often times better off taking a 2nd loan (if the plan allows) then repaying the 1st loan. 

In that example the person with an $80k balance and an $18k loan balance could take ANOTHER $22k taking him to the $40k limit. (IRS seems to ignore the 12 month look back part of the rule in the example.)

If the person in the example pays the $18k he can take a $23k loan.  But that nets him an only an additional $5k and his total loan balance is the $23k. 

Everyone I know seems to acknowledge this is an odd quirk but also how the rules work. 

 

 

[Mike Preston]

ESOP Guy, the quirk you are referring to is detailed in columns L and M of the spreadsheet I posted.

[Juan Falso]

The quirks are interesting.

If perpetual loans are what is being discouraged then why is it one can borrow $25,000 pay it off after a year and borrow 25,000 again pay it off...etc.?

Once perpetuity is off the table the rule becomes a fancy way of saying don't let your combined loans go over $50k or 50%.

[Juan Falso]

Business Days	Workdays (does not include weekends or holidays)
Calendar days	Actual number of days including holidays and weekends

**Above are the only definitions of "DAY" in the IRS terms and definition chapter.

**Below is from  Collins Dictionary of Law © W.J. Stewart, 2006

DAY. A division of time. It is natural, and then it consists of twenty-four hours, or the space of time which elapses while theearth makes a complete revolution on its axis; or artificial, which contains the time, from the rising until the setting of the sun,and a short time before rising and after setting. Vide Night; and Co. Lit. 135, a. 
     2. Days are sometimes calculated exclusively, as when an act required that an appeal should be made within twenty daysafter a decision. 3 Penna. 200; 3 B. & A. 581; 15 Serg. & Rawle, 43. In general, if a thing is to be done within such a timeafter such a fact, the day of the fact shall be taken inclusively. Hob. 139; Doug. 463; 3 T. R. 623; Com. Dig. Temps, A; 3 East,407. 
     3. The law, generally, rejects fractions of days, but in some cases it takes notice of such parts. 2 B. & A. 586. Vide Date. 
     4. By the custom of some places, the word day's is understood to be working days, and not including Sundays. 3 Espin.N. P. C. 121. Vide, generally, 2 Chit. Bl. 141, note 3; 1 Chit. Pr. 774, 775; 3 Chit. Pr. 110; Lill. Reg. h. t; 1 Rop. Leg. 518; 15Vin. Ab. 554; Dig. 33, 1, 2; Dig. 50, 16, 2, 1; Id. 2, 12, 8; and articles Hour; Month; Year.

***

What is governing, an example or the code as written?  I would wager that the court records have at least a few cases where the example was followed but the individual was cited for not following the actual code.

[Mike Preston]

So, which of your clients do you volunteer to take on the IRS in this regard?

I'm usually the first one to jump on board careful readings of Code, regs, etc.

But not this time.  I think it would be very, very close to malpractice to recommend your interpretation to a client.  Remember: if a plan document has loan provisions which parrot the Code, intentionally exceeding the limits is  not only a taxable event under 72(p), it is also a disqualifying event requiring EPCRS to cure.

Too rich for my blood.

[ESOP Guy]

I am still not sure your reading of the code is solid as you say.  I used the word day here is the exact language from the code: 

the outstanding balance of loans from the plan on the date on which such loan was made, or

Clearly the IRS reads that as meaning before the new loan is issued.  It would be interesting to know if the example (or something like it) is in the regulations.  (I don't care enough to check as I think Juan is wasting his time this stuff was put out over a decade ago and is about as settled law in the pension world as settled law can be).  But if it is my experience as a tax CPA over the decades is unless you can show the IRS' interpretation of the law in regulations is simply contrary to the written law the courts give a lot of deference to the IRS. 

Maybe this kind of stuff even ties into the recent discussion of the Chevron Doctrine that has come up for debate recently in SCOTUS news. 

In the end maybe you are right Juan the IRS' postilion is too extreme or doesn't make sense.  But I have worked in this field since the very early '90s and before these rules the abuse of loans was rampant and these rules ended most of that.  Yes, I understand good intentions aren't law but it is simply true.  Back in the day I used to work on a balance forward 401(k) plan for a small employer (back then all small employer 401(k) plans were balance forward).  Two weeks after I issued the certificates to the employees the same two brothers would come in asking to refi their loan.  They would take the loan up to 50% of their new balance (the plan had a PS contribution every year).  They would move the final payment day back out to 5 years from the date of request.  It was clear they intended to retire with 50% of their retirement money in the form of a loan to themselves.  That for better or worse was seen as public policy to give tax deferred benefits to.  In my mind they were adults and they want to spend their retirement money now and eat dog food later so be it.  But my guess is those guys now are retired and my taxes are paying for them to live as they are in poverty as they clearly couldn't save.  

 

Off my soap box for now. 

[Bill Presson]

I'm always amazed (and I don't know why) at people coming to this board with "questions" and getting upset at the answers. If you're so confident in your position, why come here?

[Juan Falso]

Sorry Bill, I never intended to give the impression of being upset.  No emotional layer at all.  I just like a good discussion and I despise badly written regulations.  

I learned to fly for fun and the mentality of pilots at the airport is completely different.  They will pick apart the regulations context and verse to the most infinite degree because that is how the FAA enforces.  IRS says "we know what we wrote, but here is what we meant".. Of course going to bat against the FAA might get a license suspended for a few month whereas the DOL or IRS will just take your nest egg. 

[Kevin C]

20 hours ago, Mike Preston said:

 Remember: if a plan document has loan provisions which parrot the Code, intentionally exceeding the limits is  not only a taxable event under 72(p), it is also a disqualifying event requiring EPCRS to cure.

If that wasn't bad enough, following the plan provisions regarding loans is also a requirement for the PT exemption for participant loans. §2550.408b-1(a)(1)(iii).

[Bill Presson]

On 7/26/2017 at 5:35 PM, Juan Falso said:

Sorry Bill, I never intended to give the impression of being upset.  No emotional layer at all.  I just like a good discussion and I despise badly written regulations.  

 

I also like a good discussion about badly written regulations, so no disagreement there

[Bird]

17 hours ago, Bill Presson said:

I also like a good discussion and badly written regulations, so no disagreement there

You like badly written regulations? 

[Tom Poje]

by the way, the IRS example is (but even that might not convince someone)

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-loans

6.  Jim, a participant in our retirement plan, has requested a second plan loan. Jim’s vested account balance is $80,000. He borrowed $27,000 eight months ago and still owes $18,000 on that loan. How much can he borrow as a second loan? Would it benefit him to repay the first loan before requesting a second loan?

Jim will only be able to take a second loan if your plan’s terms allow it. You’ll find how to determine the maximum amount Jim may borrow in IRC Section 72(p)(2)(A). The law treats the portion of the loan that exceeds the maximum amount as a distribution. Generally, any previously untaxed amount of the distribution is taxable. We’ll use the facts in your question to calculate Jim’s maximum allowable loan balance.

The new loan plus the outstanding balance of all other loans cannot exceed the lesser of:

1. $50,000, reduced by the excess of the highest outstanding balance of all Jim’s loans during the 12-month period ending on the day before the new loan (in this example, $27,000) over the outstanding balance of Jim’s loans from the plan on the date of the new loan (in this example, $18,000), or
    
2. The greater of $10,000 or 1/2 of Jim’s vested account balance.

Maximum second loan if amount still owed on first loan
Jim’s current loan balance is $18,000. This amount plus the new loan cannot exceed the lesser of:

1. $50,000 – ($27,000 - $18,000) = $41,000, or
2. $80,000 x 1/2 = $40,000

Jim’s total permissible balance is $40,000, of which $18,000 is an existing loan balance. This leaves a new maximum permissible loan amount of $22,000 ($40,000 - $18,000).

Maximum second loan if first loan repaid
Because the law bases Jim’s maximum loan on all of his loans during the 12 months prior to the new loan, there isn’t a significant advantage for Jim to pay off his first loan before requesting a second. If Jim repaid the $18,000 before applying for the second loan, he would be limited to the lesser of:

1. $50,000 – ($27,000 – 0) = $23,000, or
2. $80,000 x 1/2 = $40,000

In this case, the maximum permissible loan amount would be $23,000.

[TPAJake]

This is timely, issued the 26th:

https://www.irs.gov/pub/foia/ig/spder/tege-04-0717-0020.pdf

[Bill Presson]

6 hours ago, Bird said:

You like badly written regulations? 

Ha! I meant "about". Edited mine so I don't look so terribly stupid.

[RatherBeGolfing]

1 hour ago, Bill Presson said:

Ha! I meant "about". Edited mine so I don't look so terribly stupid.

Yea but without badly written regs we would lose out on so much fun... So maybe the unedited comment wasn't so far off after all 

[Larry Starr]

On 7/26/2017 at 9:33 AM, Juan Falso said:

Source of text cited is:

https://www.gpo.gov/fdsys/pkg/USCODE-2011-title26/pdf/USCODE-2011-title26-subtitleA-chap1-subchapB-partII-sec72.pdf

Perpetual loans would imply never repaying the loan.  In the cited example the loan is repaid in full indicating a certain level of liquidity.

To the extent that you are paying an appropriate interest rate what is the concern? it is like any other investment.  One might argue that this could be a good strategy for earning a better return on cash reserves than say a regular money market acct.

I could use money from the same account to by a mcdonalds franchise, work there and never pay it off.  So is the intent really to stop one from perpetual use of the funds or is this just a long confusing way to say that your combined loans cant exceed $50,000?

No, perpetual loan contemplated having a $50,000 loan, paying it all off and borrowing it all back the same day (or next day). That is considered a perpetual loan.