Participant loan - not a segregated investment

[RatherBeGolfing]

I think the long week is getting to me because I keep questioning whether I'm looking at this correctly.  Any input greatly appreciated

• Plan has pooled/trustee directed investments
• Participant loans are allowed
• loans are NOT treated as a segregated investment

Im looking at the mechanics of the loan itself rather than fiduciary issues, but there is some disagreement in my office and this is one of those days where I would gladly take a coffee-IV.

The way Im looking at it, it is still a participant loan secured by the participant's balance. The loan interest is credited to the plan trust as a whole rather than back to the participant account.  

• Bud Weiser has a $100,000 account balance and borrows $50,000.
• for 2018, Mr Weiser has repaid $10,000, $1,000 of which was interest.
• Before Mr Weisers account is credited for 2018 earnings, his 12/31/2018 balance is still $100,000, $59,000 in pooled investments and $41,000 as a participant loan.
• The $1,000 Mr. Weiser paid as loan interest is added to the plan trust gain/loss to be allocated among pro rata for all participant ending balances
• Mr Weiser's share of the pro rata investment earnings is limited to the $59,000 that is part of the pooled investments

The opposing view is that the trust made the $50,000 to the participant as an investment, and it did not actually come from the participants account balance.  

• The 12/31/2018 balance for Mr. Weiser is $100,000 before it is adjusted for earnings
• The loan should be tracked separately from Mr. Weiser's account balance in the plan

Am I crazy, or is the opposing view describing an extension of credit (secured by plan participant assets?) as a plan investment rather than a participant loan?

Thanks

J

[ESOP Guy]

It has been over 10 years since I did balance forward 4k/PSP plans so factor that into this answer I guess.

The few times where the loan was part of the pooled investments and not a segregated investment we treated it as if the plan has invested in a bond from say IBM. 

So I think the 2nd take is correct.  The person's account is $100,000.   You total up all the pooled accounts earnings including the loan interest and allocate it like you normally would. 

In fact in one case I remember there was a down market (might have been the early 2000s) and the loans in the pooled account were what helped the total return stay positive.  There were a lot of loans. 

To me thinking of the loan as just another fixed income investment by the plan helps keep it clear.  

That was how we did it.  I don't have a cite. 

We didn't get into your legal question.  But if you are correct than it would seem like you are saying all participant loans are required by law to be a segregated investment would be the practical ramification of what you are saying. 

Out of curiosity does method #1 get him close to his $1,000 interest on his $49k plus his pro rata share of the non-loan interest earnings on his $59k?  If not, is the plan's method or earnings allocation harming him in a way that isn't legal?   I am asking not advocating a position I really am asking.  I would recommend running that math.  

[shERPA]

Agree with ESOP guy.  AFAIK DOL guidance expresses preference for loans as segregated investment, but not a requirement.  That said, read the plan doc, some of them are specific about this.  

Method 1 is excluding his participant share of interest on the pooled loan.  It would be the correct way to allocate the pooled earnings if the loan is segregated. 

[RatherBeGolfing]

16 minutes ago, ESOP Guy said:

We didn't get into your legal question.  But if you are correct than it would seem like you are saying all participant loans are required by law to be a segregated investment would be the practical ramification of what you are saying. 

Out of curiosity does method #1 get him close to his $1,000 interest on his $49k plus his pro rata share of the non-loan interest earnings on his $59k?  If not, is the plan's method or earnings allocation harming him in a way that isn't legal?   I am asking not advocating a position I really am asking.  I would recommend running that math.  

See this is why I'm questioning myself...  Each time I see it clearly another issue muddies the water.

#1 does not get him close to the earnings on loan.  Is it harming him?  Im not sure.  He gets the benefit of the loan and the interest replaces what the money in the loan can't earn outside of the trust.  

#2 gets him the benefit of the loan and full earnings on the $100k account balance even though half of is not in the trust.

The practical ramification of #1 is that the participant with the loan receives earnings on his share of the assets still in the plan, and does not get the extra benefit of replacing the earnings lost by taking the money by adding the interest payment. 

 

[RatherBeGolfing]

1 minute ago, shERPA said:

That said, read the plan doc, some of them are specific about this.

Unfortunately it is not very specific.

2 minutes ago, shERPA said:

Method 1 is excluding his participant share of interest on the pooled loan.

Is it?  He gets pooled earnings (including his share of the loan interest) on the amount still in the plan.  If he gets earnings on the full $100k, isn't he benefiting more than everyone else?

In simple numbers:

$1,000,000 in the plan

P takes out $50,000

$950,000 in the plan.

The $950,000 has earnings of $101,000 ($1,000 loan interest)

P gets a pro rata share of $101,000 based on $100,000 account balance rather than his share of the assets that are actually invested.

Doesn't this mean that everyone else is getting less earnings in the plan while he has both the loan and earnings on the non-existing loan assets in the trust?

Like I said, its one of those days when things are not making sense to me.

[ESOP Guy]

On 8/16/2019 at 2:43 PM, RatherBeGolfing said:

In simple numbers:

$1,000,000 in the plan

P takes out $50,000

$950,000 in the plan.

The $950,000 has earnings of $101,000 ($1,000 loan interest)

P gets a pro rata share of $101,000 based on $100,000 account balance rather than his share of the assets that are actually invested.

Doesn't this mean that everyone else is getting less earnings in the plan while he has both the loan and earnings on the non-existing loan assets in the trust?

Like I said, its one of those days when things are not making sense to me.

P gets a pro rata share of $101,000 based on $100,000 account balance rather than his share of the assets that are actually invested.

I am not sure I agree with that statement.  Isn't this person invested in the $50k (ie loan) that earned the $1,000 interest?   His account is clearly still $100k.  The $50k loan this person took is an investment the plan holds

Your statement seems to imply the $50k in his account is missing from the plan but it isn't.  It is the loan and making a return based on the interest the loan is adding to the plan. 

This might be a good reason to change the plan going forward to make new plan loans a segregated involvement.  Not sure you can change it for existing loans.  I know that doesn't help you in the here and now.  

[ESOP Guy]

I do appreciate the problem.  I hope I am making it clear I don't think my view has to be correct.  This is one of those areas where you better be humble as there isn't a clear answer.

[RatherBeGolfing]

15 hours ago, ESOP Guy said:

I do appreciate the problem.  I hope I am making it clear I don't think my view has to be correct.  This is one of those areas where you better be humble as there isn't a clear answer.

No worries I appreciate the discussion because I'm really not sure I'm looking st it the right way either.  I'm leaning towards my initial view being wrong.  I'm ok doing it either way, I just want to have a some backup for how I do it.

[CuseFan]

On 8/16/2019 at 12:42 PM, RatherBeGolfing said:

Am I crazy, or is the opposing view describing an extension of credit (secured by plan participant assets?) as a plan investment rather than a participant loan?

No, you are not crazy but that is exactly the proper accounting treatment (it is still a participant loan and a plan investment, just not a participant directed/segregated investment). This was how all loans used to be administered before the days of any participant investment direction (for those of us old enough to remember). That is also a primary reason for the long standing requirement that the loan bear a market rate of interest.

 

[Larry Starr]

No question; option 2 is the correct method.  Your method is most likely incorrect unless there is some very specific language in the document that would direct such handling (which I'm sure there isn't).

Larry.

[Tigerket]

DOL participant loan regulation recognizes as legit  loans from pooled investment and from individual account. Difference is in the collateral. If loan comes from pool, the collateral has to be sufficient to repay the pool if there is a default, and before there is a distributable event so plan can actually collect on the collateral.  Doesn’t this make it difficult to make participant loans from the pool? And doesn’t 408(b)(2) make it a PT for a plan to treat a partipant  loan from pooled investment as just an investment?

[ESOP Guy]

1 hour ago, Tigerket said:

DOL participant loan regulation recognizes as legit  loans from pooled investment and from individual account. Difference is in the collateral. If loan comes from pool, the collateral has to be sufficient to repay the pool if there is a default, and before there is a distributable event so plan can actually collect on the collateral.  Doesn’t this make it difficult to make participant loans from the pool? And doesn’t 408(b)(2) make it a PT for a plan to treat a partipant  loan from pooled investment as just an investment?

I am not a PT expert so I am not going to speak to that.  But I used to do a lot of balance forward 4k and PSP plans back in the day that were pooled and some of them them used method #2 above for the loans.  The collateral issue is no different than with a separate investment or daily recordkeeping.   If the person defaults you reduce the account balance of the person who took the loan' and the rest of the participants are still whole.   I saw the math all the time back then.  You might be able to quibble about some lost interest to the rest of the people depending on how much time passed from last payment to default.

In fact it was this experience that convinced me that the idea you should only be able to take 50% of your balance because the other 50% had to "secure" you loan was a rule written by someone who didn't think very deep on this topic.  

There is no form of recordkeeping I have found that the loan isn't self collateralizing.   A default happens you reduce the person's balance and no one is out of any amount of money.  It always balances out so if security is the only issue you should be able to take 100% of your balance.  If they just want to make a limit for the sake of a limit fine make it 50% but need idea you need the other 50% as collateral is not a valid reason for the 50% limit as far as I am concerned.  

Off my soapbox now.   

[RatherBeGolfing]

Thanks all.  I have come to my senses and will move forward accordingly, along with a recommendation to amend the plan and loan policy to treat future loans as a segregated investment.  

 

[shERPA]

The plan administrator could also probably change the treatment of existing loans once they amend the plan provision. I don’t think there is anything protected about this. Just make the change as of a valuation date, unless there is some plan provision that precludes it.  Better to have them all treated the same way IMO.  Less chance of error.

 

[Tigerket]

On 8/19/2019 at 6:37 PM, ESOP Guy said:

I am not a PT expert so I am not going to speak to that.  But I used to do a lot of balance forward 4k and PSP plans back in the day that were pooled and some of them them used method #2 above for the loans.  The collateral issue is no different than with a separate investment or daily recordkeeping.   If the person defaults you reduce the account balance of the person who took the loan' and the rest of the participants are still whole.   I saw the math all the time back then.  You might be able to quibble about some lost interest to the rest of the people depending on how much time passed from last payment to default.

In fact it was this experience that convinced me that the idea you should only be able to take 50% of your balance because the other 50% had to "secure" you loan was a rule written by someone who didn't think very deep on this topic.  

There is no form of recordkeeping I have found that the loan isn't self collateralizing.   A default happens you reduce the person's balance and no one is out of any amount of money.  It always balances out so if security is the only issue you should be able to take 100% of your balance.  If they just want to make a limit for the sake of a limit fine make it 50% but need idea you need the other 50% as collateral is not a valid reason for the 50% limit as far as I am concerned.  

Off my soapbox now.   

A loan from a plan to a participant is a prohibited transaction unless the plan follows the requirements of the statutory exemption in 408(b)(2), and the terms of the DOL plan loan regulation in which the DOL hammered home that approving a participant loan was a fiduciary act, that the loan had to have reasonable rate of interest, be adequately collateralized, etc etc.  The 50% rule was written by a DOL who thought deeply, or at least exclusively, about protecting the plan assets, and was reacting to abusive loan practices in ERISA's early days.   There were also lots of concern generally about premature distributions.  So -- weren't plans in a catch 22 on the account balance collateral problem with loans from pooled investment vehicles?  The DOL position seemed to be that in the event of a default, the plan had to collect on the collateral to protect the investment,  but the IRS made it clear that a plan risked disqualification if on the  default the plan tried to collect on collateral from a participant's account at any time before that participant had a distributable event.  Hence, a participant borrowing from a pooled investment vehicle could not borrow anywhere near 50%, in order for there to be sufficient assets left to his or her credit to pay interest into the pool until the defaulting participant had a distributable event.  Based on these concerns - doesn't it look like  the special provisions in the DOL plan loan regulation essentially limited using the account balance as collateral to loans from a participant's individual account?  So the participant hurt only him/herself, and the carried interest was treated as a paper transaction until a distributable event?  The IRS even said after the DOL reg was final that the plan did not have to issue a 1099 every year until a distributable event to report the " interest" on the defaulted loan as "income."  

Didn't some plans with pooled investments avoid the whole problem by rewriting the plan to segregate participant loans? 

Off my archival box now.