allow a second loan only to certain participants?

[AlbanyConsultant]

403b Plan D was at Recordkeeper R about ten years ago.  They had about 20 participants with defaulted loans.  Recordkeeper R is an insurance company, so they treat the loans as loans from the vendor.  The plan converted to a new recordkeeper, but R said that they have to maintain the defaulted loans.  We came into the picture a couple of years later and weren't successful at getting them to change their mind.

Now participants who have these old defaulted loans are looking to take a new loan - they call the new recordkeeper who of course has no information on these old defaulted loans and are told that they can certainly take a loan.  Then all sorts of headaches ensue.

Let's say that repaying the defaulted loans with accrued interest is not an option - almost all of them are for workers just above minimum wage.  They're basically taking a loan to get access to the profit sharing while still employed.  The plan currently doesn't allow age 59.5 ISW, but most are under that age anyway.

Can we amend the plan to allow for a second loan ONLY to participants who have a defaulted loan at Recordkeeper R?  There are no HCEs in that situation, so from a purely mathematical standpoint, it should be fine.

Note that this is not what I'm suggesting they do.  I'm just looking for options... and will gladly take any others.

Thanks!

[Artie M]

Since you do not have HCEs this should be doable.  The Plan docs would have to be amended to provide for this.  Usually, this would be a BRF as loans should be available to all participants on a reasonably equivalent basis and, as such, offering one to some and two to others would need to be tested.  But if NO HCEs this difference would satisfy BRF testing (not sure "if no HCEs in that situation" means something else).  Just have this rule set forth as an objective rule.  The outstanding loan is still count for maximum loan purposes.   (Just note that some commentators have stated that any loans after a deemed distributed defaulted loan is also considered a deemed distribution, but I have never seen authority for that statement. Plus that never made sense to me... just say if have deemed distributed defaults loan can't give another loan... but that isn't said anywhere either.) 

[Peter Gulia]

Beyond tax law, consider whether a suggested plan provision would result in participant loans that “[a]re available to all . . . participants and beneficiaries on a reasonably equivalent basis[.]”

29 C.F.R. § 2550.408b-1(a)(1)(i) https://www.ecfr.gov/current/title-29/section-2550.408b-1.

That’s a condition of the statutory prohibited-transaction exemption.

[David D]

You would also want to review the plan loan policy in place. Most loan policies that i see say that if a participant defaults on a loan, that participant cannot take another loan.

[Artie M]

After seeing the follow up posts, I reread the OP and have a couple other items to note.   The prior recordkeeper is doing what is required under the Regulations.  I don't believe they have a choice "to change their mind."  As previously noted, the defaulted loan must be taking into account in determining the limits on any new loan but I omitted the requirement that "phantom interest" also must be taken into account for those purposes.  See Treas. Reg. §1.72(p)-1 Q&A 19 ("A loan that is deemed distributed under section 72(p) and that has not been repaid...").

[AlbanyConsultant]

3 hours ago, David D said:

You would also want to review the plan loan policy in place. Most loan policies that i see say that if a participant defaults on a loan, that participant cannot take another loan.

Believe me, this is where I started the argument against even considering this.

 

 

4 hours ago, Peter Gulia said:

Beyond tax law, consider whether a suggested plan provision would result in participant loans that “[a]re available to all . . . participants and beneficiaries on a reasonably equivalent basis[.]”

29 C.F.R. § 2550.408b-1(a)(1)(i) https://www.ecfr.gov/current/title-29/section-2550.408b-1.

That’s a condition of the statutory prohibited-transaction exemption.

This is what I was afraid of.  I mean, not "afraid", since I'm glad to not have this as a recommended option.

[Bantais]

On 3/10/2026 at 2:42 PM, AlbanyConsultant said:

403b Plan D was at Recordkeeper R about ten years ago.  They had about 20 participants with defaulted loans.  Recordkeeper R is an insurance company, so they treat the loans as loans from the vendor.  The plan converted to a new recordkeeper, but R said that they have to maintain the defaulted loans.  We came into the picture a couple of years later and weren't successful at getting them to change their mind.

Now participants who have these old defaulted loans are looking to take a new loan - they call the new recordkeeper who of course has no information on these old defaulted loans and are told that they can certainly take a loan.  Then all sorts of headaches ensue.

Let's say that repaying the defaulted loans with accrued interest is not an option - almost all of them are for workers just above minimum wage.  They're basically taking a loan to get access to the profit sharing while still employed.  The plan currently doesn't allow age 59.5 ISW, but most are under that age anyway.

Can we amend the plan to allow for a second loan ONLY to participants who have a defaulted loan at Recordkeeper R?  There are no HCEs in that situation, so from a purely mathematical standpoint, it should be fine.

Note that this is not what I'm suggesting they do.  I'm just looking for options... and will gladly take any others.

For participants who are struggling with access to funds and can’t repay old loans, having alternative options can also help avoid these headaches. Services like fcloans provide fast and transparent personal or small business loans, which could give employees access to needed funds without further complicating the 403b plan. While it doesn’t replace the plan itself, it can be a practical way to help people manage short-term cash needs responsibly.

Thanks!

From a plan design perspective, amending the plan to allow a second loan specifically for participants with a prior defaulted loan could be possible, but you’d need to make sure it complies with IRS rules on participant loans, including aggregate loan limits and nondiscrimination requirements. Since there are no HCEs affected, the nondiscrimination concern may be minimal, but you’ll still want to ensure the amendment is carefully drafted so it doesn’t unintentionally create compliance issues.

Another option could be to establish a clear communication process for participants with these old loans, clarifying their loan eligibility and the consequences of taking a new loan. Sometimes having a standardized procedure or policy memo can prevent future headaches and make it easier for the recordkeeper to manage requests consistently.

It’s definitely a situation where consulting a plan attorney or ERISA specialist could help outline safe approaches without running afoul of plan or IRS rules.