Loan percentage for borrowing from a pension plan

[Jakyasar]

Hi

Have not dealt with loans for couple of years and now a participant wants one. Loan procedure states prime rate plus 1%. Is this reasonable? I believe 2% is the unofficial safe harbor.

Thank you

[Riley Britton]

It's the weekend!!! 

[BG5150]

People have been using prime +1 without consequence (that I know of) for years now.

 

[Peter Gulia]

For a loan to a participant to meet an exemption from prohibited-transaction consequences (under both ERISA’s title I and Internal Revenue Code § 4975), the loan must “earn a reasonable rate of interest[.]”  29 C.F.R. § 2550.408b-1(a)(1)(iv).  Further, the rule states: “A loan will be considered to bear a reasonable rate of interest if such loan provides the plan with a return commensurate with the interest rates charged by persons in the business of lending money for loans which would be made under similar circumstances.”  29 C.F.R. § 2550.408b-1(a)(1)(iv).  The rule includes three examples of facts and circumstances that do not result in a reasonable interest rate.

 

Some fiduciaries adopt a procedure for setting a loan interest rate based on a “prime” interest rate, with an increase of zero, 100, or 200 basis points.  This might be based on an IRS employee’s remarks that burden no one, not even the IRS.  Without reopening that discussion, here’s my question:

 

Has anyone seen the Employee Benefits Security Administration or the Internal Revenue Service pursue enforcement for a too-low loan interest rate?

 

If so, what was the agency’s explanation about why the rate was too low?

 

[Peter Gulia]

I don't know why the software shows in bold a text I hadn't set that way.

 

[david rigby]

1 hour ago, Peter Gulia said:

I don't know why the software shows in bold a text I hadn't set that way.

Edited.

[Peter Gulia]

Thanks.

Has anyone seen the Employee Benefits Security Administration or the Internal Revenue Service pursue enforcement for a too-low loan interest rate?

 

If so, what was the agency’s explanation about why the rate was too low?

[Gilmore]

This might be helpful, at least with respect to where the 2% comes from.  I remember this call.

 

[Patricia Neal Jensen]

Prime plus 2% is the "unofficial approved rate."  Even that is probably too low for the "rate at which the participant could borrow" test.

[RatherBeGolfing]

2 hours ago, Gilmore said:

This might be helpful, at least with respect to where the 2% comes from.  I remember this call.

 

Ha ha, I remember that call too.  I also remember that plenty of people called them out on it, pointing out that some people could indeed get a secured loan at Prime, and certainly at P+1.   And seem to recall that they had to come out with commentary after this call, clarifying the they NOT say that Prime+1 was unreasonable, even though that was pretty much what the presenter said while pushing P+2.  In fact, don't they still to this day refuse to say whether P+1 is reasonable or unreasonable?  And they still approve documents (or at least they did before post-PPA) with an option to hardcode interest at P, P+1, or P+2.

 

[David Schultz]

On ‎12‎/‎7‎/‎2020 at 7:58 PM, Patricia Neal Jensen said:

Prime plus 2% is the "unofficial approved rate."  Even that is probably too low for the "rate at which the participant could borrow" test.

A participant loan in a participant-directed account is a fully-secured loan for which no one but the participant bears the financial risk of default.  I think prime + 1% or 2% is fully supportable as a reasonable rate under those circumstances.

[BG5150]

How old is that phone forum?  7-8 years?

In that time has any audit or investigation ever have a problem with prime +1 or even prime?  I'm sure we would have heard it through the grapevine somehow.

[RatherBeGolfing]

1 hour ago, David Schultz said:

A participant loan in a participant-directed account is a fully-secured loan for which no one but the participant bears the financial risk of default.  I think prime + 1% or 2% is fully supportable as a reasonable rate under those circumstances.

Yep, this was the counter the IRS faced as soon as that phone forum was over.  

[RatherBeGolfing]

22 minutes ago, BG5150 said:

How old is that phone forum?  7-8 years?

In that time has any audit or investigation ever have a problem with prime +1 or even prime?  I'm sure we would have heard it through the grapevine somehow.

I think comments and "recommendations" have been made, but I can't recall hearing that someone got in trouble specifically for using P+1

[Luke Bailey]

I would add to the above that the DOL's loan regs came out in the very late 80's, when, rounding up to keep the math simple, the prime rate was around 10%. Adding 1% was a 10% premium, 2% 20%. Today, with a prime (rounding down this time to keep the math simple) of around 3%, 1% is a 33.33% premium. Everything is relative, and I'm thinking 1% is very conservative for our current interest rate environment.