Participant loans - part of a vested balance or no?

[blguest]

Based on documents from several different plans, I've operated under the assumption that a participant's non-defaulted loans from a DC plan reduce the vested portion of a total account balance, even though they do not reduce the overall total account balance for other purposes, such as for calculations of assignments to alternate payees (except where the loans would limit the assignable amount), because non-defaulted loans are considered assets of an account, even if they reduce the vested portion. Am I wrong, or do different plans handle this in different ways?

[fmsinc]

First you need to understand that a DC loan is not a loan at all, at least not in the way we think of loans from a lender.  If you take a loan from your 401(k) you are borrowing the money from yourself.  When you pay it back you are paying it to yourself and you are paying the interest to yourself.  It is more like taking $20 from the cookie jar in the kitchen on Monday and paying back $21 the following Monday. The only penalty is that the outstanding "loan" will not be adjusted for earnings or losses - so  for all intents and purposes it is not part of your vested accounts. 

If you are dealing with QDROs you need to state whether or not the computation of the Alternate Payee's share includes (disregards) the loan or excludes (net out) the loan. 

If you retire and take a distribution the distribution will be net of the loan balance remaining due and will be treated as a taxable event.

David 

[blguest]

Hi David, yes, there is nothing mysterious about DC loans not being loans in the traditional sense, nor how they are treated in QDROs.

The question, which I likely could have posed in a less oblique way for better clarity, is whether some plans treat non-defaulted loans as "vested", even though you and I would not consider loaned-out money as "vested" because it isn't liquid or available for payment to an alternate payee.

The reason I asked Benefits Link neighbors the question is because I have seen some plans' documentation containing specific language stating as much, while others have (unofficially) stated they consider non-defaulted loans to retain their vested character unless defaulted. That latter interpretation seems nonsensical to me, particularly with respect to property division cases.

Perhaps others here could enlighten us both.

[Bri]

Is this a question of whether or not a defaulted loan for someone at 60% vesting, would then leave all their other funds at exactly 60% vested still?

[Peter Gulia]

For an individual-account retirement plan that provides participant loans, a plan’s loan receivable is the plan’s asset, and typically is allocated to the individual account of the borrower participant (especially so if the plan provides participant-directed investment).

Yet, how to account for, and how to value, such a loan receivable for each of several differing purposes involves other layers of questions. For just one example about only two of the purposes, a value shown in an element of a plan’s financial statements might differ from a value (if any) shown on a participant’s account statement.

If the only security for a participant loan is a set-off or charge against the elective-deferral subaccount of the participant’s individual account, questions about whether a benefit right is not yet nonforfeitable might be inapplicable.

Consider that a retirement plan’s documents might state or describe a benefit right in a way that, while perhaps logically fitting the Internal Revenue Code and ERISA’s title I, has little or no relevance for some practical uses of the benefit right.

A negotiator for a nonparticipant spouse might argue that such an alternate payee’s share ought to be determined or negotiated by assuming as the starting point what the participant’s account would be, and what the marital-property  portion of it would be, had the participant not taken the loan. That might make sense if only the participant would benefit from repaying the loan.

Likewise, domestic-relations negotiators might focus on what amounts could be payable in tomorrow’s QDRO division and distribution.

This is not advice to anyone.

[Paul I]

An outstanding loan balance does not reduce the vested balance in the plan.  The loan is an asset that is part of the overall plan account.

It is included in the formula for determining the amount available should the participant is permitted to and wishes to take out a second loan.

It is included in the total value of the vested account balance payable upon distribution (and any unpaid loan balance at the time of distribution is taxable.)

For a QDRO, how it is handled is subject to the agreed-upon terms of the QDRO.  (Commonly, the party who is the participant in the plan keeps the loan and continues to make loan repayments by payroll deduction, but if the plan loan procedures facilitate it, the alternate payee could agree to have part of the loan kept in the alternate payee's account inside the plan and make payments on the loan.

[QDROphile]

Good written QDRO procedures will provide that account assets other than the loan will be used to create the alternate payee’s subaccount.

The risk of vesting and default fall on the participant, but the plan can make it stick. The alternatives are administrative nightmares.