Denying a plan loan

[Luke Bailey]

10 hours ago, Mike Preston said:

It seems more complicated only because saying it your way is wrong. You can confirm this simply by considering what happens when the first loan payment is made. 

Mike, if the loan is treated as an individually directed investment for all purposes, the first (second, third, etc.) loan payment is credited to the participant's account. The principal portion of the payment reduces the outstanding principal of the loan and the interest portion is the borrowing participant's investment gain for the portion of his/her account that consists of the loan. Since the loan was treated as an asset of the participant's account, reduction of its principal is not a gain or loss, just the replacement of a portion of one asset (the debt) by another (cash). The other participants get whatever the gain or loss is from the rest of the portfolio. How is that complicated?

[Luke Bailey]

11 hours ago, Mike Preston said:

It seems more complicated only because saying it your way is wrong. You can confirm this simply by considering what happens when the first loan payment is made. 

Mike, the first loan payment is made. It is cash. The principal portion of the payment reduces the outstanding loan amount. The interest portion is treated as investment earnings of the borrowing participant's, and only the borrowing participant's, account. The other participants all have a slightly larger share of the earnings of the pooled investments than they would if the earnings were spread based on gross account size, and the borrowing participant a smaller share, because we are spreading earnings based on gross account size net of the outstanding balance of any participant loan allocated to the account, not gross account size. The cash from the first payment is immediately invested in the pooled investments, but because it reduces the outstanding amount of the loan (including the accrued interest since the last payment) allocated to the participant's account, it increases the borrowing participant's account size, net of the outstanding amount of the loan, for purposes of spreading future pooled earnings. That does not seem complicated to me.

[chc93]

2 hours ago, Luke Bailey said:

Mike, if the loan is treated as an individually directed investment for all purposes, the first (second, third, etc.) loan payment is credited to the participant's account. The principal portion of the payment reduces the outstanding principal of the loan and the interest portion is the borrowing participant's investment gain for the portion of his/her account that consists of the loan. Since the loan was treated as an asset of the participant's account, reduction of its principal is not a gain or loss, just the replacement of a portion of one asset (the debt) by another (cash). The other participants get whatever the gain or loss is from the rest of the portfolio. How is that complicated?

I would have thought that the interest portion is part of the net gain of the pooled trust... and allocated to all participants.  The principal portion reduces the outstanding balance of the loan... which has "assigned" to the participant.

[Luke Bailey]

23 minutes ago, chc93 said:

I would have thought that the interest portion is part of the net gain of the pooled trust... and allocated to all participants.  The principal portion reduces the outstanding balance of the loan... which has "assigned" to the participant.

chc93, I was trying to illustrate the effect of treating the participant loan as a segregated investment of the borrowing participant for all purposes, even in a DC plan where the rest of the investments are pooled. In such a case, the rate of return on the loan (i.e., the loan interest), whether more or less than the plan's rate of return for the same period, would be assigned to the participant. Thus, for example, if it were less over the life of the loan than the rate of return of the other plan investments, the borrowing participants, as a group, would take the hit, not the nonborrowing participants. The converse would, of course, also be true, as well as being less likely.

[Mike Preston]

Luke, review what you said before my response. You think pooled is more complicated. I don't. 

[Luke Bailey]

16 minutes ago, Mike Preston said:

Luke, review what you said before my response. You think pooled is more complicated. I don't. 

Mike, not sure, but you may be getting a little subtle on me. If it helps, I will concede that just putting the cash back into the common investment pool and spreading the pool's investment return over the gross value of all accounts, including loans, is simpler in terms of recordkeeping steps. I think it is a more complex idea to communicate to participants, however, both those who take loans and those who don't, than simply saying, "You borrow from your own account and your account owns all of the loan, for good or ill." Certainly that's a better basis for making a loan to someone who just filed for Chapter 13, which was the OP. I am old enough to remember that VisiCalc was the first spreadsheet, or close to it, but now that they teach Excel in grade school, it's going to be pretty simple to recordkeep either way. So even in a DC plan that pools everything else, I would recommend not pooling participant loans. Does that settle it?

[Mike Preston]

Pretty much. I guess we just have to disagree on what is perceived as simple by whom. 

[Luke Bailey]

Yeah. It's complicated.

[Larry Starr]

21 hours ago, Luke Bailey said:

chc93, thanks. I think that is the only right answer.

It's what we have been saying all along......

So in effect the loan is allocated as an individually directed investment of the borrower's account in the case of default, but not for "normal" rate of return purposes, i.e., interest.

NO.  You can call an elephant a horse, but he is still an elephant!  There is no "in effect" here. What happened is a very  normal financial transaction.  The participant's account has a LIEN against it IN CASE the loan is not paid back.  That is true whether pooled or not. It's required by the loan rules.

Seems more complicated than just saying that, whether or not the rest of the plan's investments are pooled or individually directed, a participant loan is treated as an individually directed investment of the borrowing participant for all purposes.

It may seem simpler, but it is just plain wrong.

 

[Larry Starr]

23 minutes ago, Luke Bailey said:

Mike, not sure, but you may be getting a little subtle on me. If it helps, I will concede that just putting the cash back into the common investment pool and spreading the pool's investment return over the gross value of all accounts, including loans, is simpler in terms of recordkeeping steps. I think it is a more complex idea to communicate to participants, however, both those who take loans and those who don't, than simply saying, "You borrow from your own account and your account owns all of the loan, for good or ill." Certainly that's a better basis for making a loan to someone who just filed for Chapter 13, which was the OP. I am old enough to remember that VisiCalc was the first spreadsheet, or close to it, but now that they teach Excel in grade school, it's going to be pretty simple to recordkeep either way. So even in a DC plan that pools everything else, I would recommend not pooling participant loans. Does that settle it?

Well, of course, you can recommend anything you want.  Since we service hundreds of plans, we will continue to run them the way WE think is best so long as the client is ok with that (and since they have no clue what it all means, they are always OK with that).