Loan to Fund Retirement Plan

[Jennifer D.]

So here's a new one for me:  We have a client who has not funded the employer contributions to the plan since 2013.  He would like to take a loan from his account under the plan and use that money to fund the plan.  The kicker is that he has already defaulted on a prior loan.  The loan policy could be amended to permit him to take a loan even after a default and we could include the prior loan and missed interest when calculating how much he can take out to fund the plan.  BUT, this isn't passing my smell test.  I fear this would be considered a prohibited transaction because it's the employer who already defaulted, and while he may use the money to fund the plan, he might not pay it back again.

Thoughts?

[Tom Poje]

even if he defaulted on a loan, that loan continues to accrue interest (on paper) so when if he tries to take a new loan that counts against his outstanding balance, so it might be a moot point anyway if he can fund a plan this way.

[Belgarath]

Unless it was offset. Could have been...

[Jennifer D.]

We believe he will still have enough to fund at least some after he pays back the missed interest, so assume that's the moot point.  I'm more worried about the prohibited transaction.  The policy permits a loan for any reason, but he's a previously defaulted trustee who wants to fund the plan with his account....

[ETA Consulting LLC]

How old is the owner?  Is he, otherwise, entitled to the distribution under the plan?  As Belgarath alluded, it's only on the books as a defaulted loan until a distributable event (i.e. 59-1/2), and then it becomes as actual distribution of the loan (aka loan offset).

If this has happened previously (i.e. more than 12 months ago), then he may very well have $50K available in loans.  If this is the case, then issue the loans under the terms of the plan, write him a check, and let him do with those funds what suits him best (as it is no longer a plan issue).

Good Luck!

[Mike Preston]

Make sure he runs it by his accountant.  There are additional issues if the form of organization is not taxed as sole prop or partnership.

[ESOP Guy]

Is there any cash in his account?  The way the OP reads he is borrowing 50% (ignoring max loan issues for now as that seems covered) of his account balance that is nothing but a large AR to the plan from the sponsor.  Or is there cash in his account and he is going to in effect put that into the other people's accounts with the loan?  Are the ER cont mandatory?  If not, why is he declaring cont he can't fund? 

All of that aside most (if not all) of these cont count for the current year's 415 limit so make sure he doesn't blow that also.