2nd Loan... have I been doing it wrong?

[K-t-F]

A client want's to take a second loan.  I looked at the IRS' explanation and it is not how I have been calculating 2nd loans.  In the end I have been more strict (it appears).  Am I wrong?

Here is the link to the IRS' example

IRS Example / My comments in blue

Jim’s vested account balance is $80,000. He borrowed $27,000 eight months ago and still owes $18,000 on that loan. Jim wants to take a 2nd loan.  What can he borrow?

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).

I always said that you take the vested balance to find the maximum loan amount for the 1st loan.  
If a 2nd loan is requested regardless of whether the 1st is paid off or not, this is how you calculate the maximum allowed:

  First, determine what the maximum loan amount can be right now
  Next, If the participant has an existing loan (or had a loan in the past 12 months), look to see what the highest balance of that loan was and subtract it from what the participant's could borrow now had s/he never had a loan
  THAT is what they can borrow.

Using the IRS' example I would say that Jim could only borrow $13,000  ($40,000 maximum allowable less highest outstanding balance in the past 12 months or $27,000..... 40,000 - 27,000 = 13,000), not $22,000

It's a big difference.  The IRS' example is more beneficial.  Have I been wrong all these years? 

[Bri]

Only the 50,000 statutory maximum gets reduced by the highest balance in the previous 12 months.  You don't do that same lookback with smaller loan amounts.  Those just have the usual 50% limitation.

[K-t-F]

My client has a plan balance much greater than $100K.  So using the example above he would only be eligible for a second loan equal to $23,000.   That would be what I tell him.

But please explain your comment...  In the IRS example Jim only has a $80k vested balance so he can take a $40K loan ... but you are saying for his second loan we don't use $40K we use the maximum $50K?

[Lou S.]

The limit is the lessor of 2 numbers which are "1/2 vested account balance" or "$50,000 reduced by highest balance in the last 12 months".

So if his vested balance is over $100,000 the $50,000 reduced by the highest outstanding balance in the last 12 months should always be the smaller number.

[K-t-F]

That's how I've always done it.  In the IRS' example for someone who does not have a vested balance that would allow them to take a $50K loan, the 2nd loan amount doesn't make sense to me.  I would think you take the most that the participant can borrow  and use that figure instead of the $50K figure. 

Honest, I'm not going to worry about it.  It's just nice to throw an IRS link at the financial advisor backing up what you tell them.  

Thanks for responding.

[ESOP Guy]

it has been a very long time since I have done 4k loans but I do think you have been doing it wrong.  Here is the code.

Notice in the highlighted part the highest balance over 12 months ONLY applies to the $50,000 limit. 

You see it doesn't apply to the 50% of the balance (blue line under it).

 

What I have always thought stupid is that paying off the first loan and ending up with just one loan will just about always (maybe always) hurt the person wanting to take out the new loan .

 

[jsample]

I copied the attached worksheet from somewhere a long time ago - please note, it may not be 100% correct and should not be relied upon without additional verification.  When I enter the numbers from the IRS' example, I get new loan available of $22,000, the same as they did.  When I make the vested balance more than $100,000, I get an additional loan available for $23,000.

Loan worksheet.xls

[BenefitJack]

Multiple loan rules according to the IRS:  https://www.irs.gov/retirement-plans/issue-snapshot-borrowing-limits-for-participants-with-multiple-plan-loans