CARES Act - Increase in Participant Loan Limits

A large, mid-Atlantic recordkeeper has advised our client that while it can increase its loan limit to $100k, they recommend the client not increase to 100% of the vested balance but instead stand pat at 50% (or perhaps 75% if the client feels strongly about it), citing to ERISA's adequate security requirement (one of the requirements such loans have to satisfy to come within an exemption to the prohibited transaction rules).   Has anyone else encountered this concern or otherwise got thoughts?

1 hour ago, EBECatty said:

I will keep beating this horse until it gives. Look at Notice 2005-92. It's not CARES Act guidance, but interprets the exact same statutory language in Section 103 of KETRA. Footnote 3, on page 14, reads:

The Department of Labor has advised the Department of the Treasury and the Service that it will not treat any person as having violated the provisions of Title I of the Employee Retirement Income Security Act (ERISA), including the adequate security and reasonably equivalent basis requirements in ERISA section 408(b)(1) and 29 CFR 2550.408b-1, solely because the person made a plan loan to a qualified individual in compliance with KETRA section 103, Code § 72(p), and the provisions of this notice. 

I can't imagine the DOL now reversing course and asserting an ERISA violation based on a lack of adequate security, especially where doing so would render the statute's explicit loan increase illegal for anyone with a vested balance below $100,000. 

100% this.  

2 hours ago, CMC said:

A large, mid-Atlantic recordkeeper has advised our client that while it can increase its loan limit to $100k, they recommend the client not increase to 100% of the vested balance but instead stand pat at 50% (or perhaps 75% if the client feels strongly about it), citing to ERISA's adequate security requirement (one of the requirements such loans have to satisfy to come within an exemption to the prohibited transaction rules).   Has anyone else encountered this concern or otherwise got thoughts?

As noted by others, it is not going to be a violation of the adequate security requirement.  Nonetheless, it is just plain stupid and I have said that from the day they raised the possibility.  As most of you know, I deal almost exclusively with trustee directed pooled asset plans. The plan loans 100% of the participant's account, say $75,000. There is now an asset worth $75,000 as part of the plan. The rest of the assets go DOWN a bit; the participant's account is now LESS THAN $75,000 and a default means the other participants suffer a loss. I have been saying if you have to do it, leave it at 50% OR maybe go as high as 80% (I like 76% even better). In participant directed accounts, it might be a different story, but we don't have loans in 99% of our plans anyway!!! ?

Even if a plan provides participant-directed investment and a loan does not affect the account of anyone beyond the participant who takes the loan, there might be reasons a plan’s sponsor could be reluctant to allow a 100% loan.

Imagine this hypothetical illustration:  Pat is 45.  Pat’s spouse is positive for coronavirus.  Just before taking a loan, Pat’s account balance (all non-Roth) in fund shares was $100,000.  Pat’s 100% loan is $100,000 for 72 months.  The monthly repayment is $1,657.29; but Pat takes the CARES Act delay.

About eight weeks or two months later, Pat is severed from employment.  Pat’s loan receivable then is about $101,000.  The plan’s administrator gives Pat an opportunity to repay the loan, but Pat lacks money.  Meanwhile, Pat’s fund shares dropped to $75,000.

What amounts will the plan’s trustee tax-report as a set-off distribution and as a deemed distribution?

How much in income taxes will Pat owe?

I do not suggest it is a bad thing for a plan’s sponsor to allow choices, including difficult choices.  But some sponsors might prefer to moderate the range of those choices.

ERISA § 408(b)(1)(E)’s adequate-security condition partially protects “the plan” against some potential consequences of a borrower’s default on a loan.  For a participant-directed plan, the condition might protect an individual’s account.

Even if no one fears any enforcement on a nonexempt prohibited transaction or on a fiduciary’s breach in allowing the transaction, a plan’s sponsor as a non-fiduciary might consider security for a loan in deciding what a plan should provide.

4 hours ago, Peter Gulia said:

About eight weeks or two months later, Pat is severed from employment.  Pat’s loan receivable then is about $101,000.  The plan’s administrator gives Pat an opportunity to repay the loan, but Pat lacks money.  Meanwhile, Pat’s fund shares dropped to $75,000.

 

What amounts will the plan’s trustee tax-report as a set-off distribution and as a deemed distribution?

 

How much in income taxes will Pat owe?

 

I can pretty much guess and I don't think the results in this case argue for a limit of less than $100,000.  Guess 1: Tax reporting will show $101,000 as a taxable distribution.

Guess 2: If Pat elects tax will be owed on the entire amount spread over three years, reduced of course by amounts rolled over as per the rollover provisions.

Pat's fund shares is a red herring. Most people who take a distribution in this fashion will spend a good chunk of it on living expenses in the near future.  Pat's assets are expected to dissapate. 

I know Mike describes the fund shares as a red herring but Pete (or Mike) can you elaborate on how the fund shares might factor in at the time of default and reporting of the default amount, etc.?  If Pat took 100% of Pat's account balance as a loan, what fund balance would there be to have dropped down to 75% of original value as of the time of the loan?   Does that suggest the plan keeps Pat's individual account invested in the funds held at the time the loan was made and the money loaned to Pat was made available from some source other than liquidating Pat's actual investments in the funds to make the loan?

10 minutes ago, Eric Taylor said:

I know Mike describes the fund shares as a red herring but Pete (or Mike) can you elaborate on how the fund shares might factor in at the time of default and reporting of the default amount, etc.?  If Pat took 100% of Pat's account balance as a loan, what fund balance would there be to have dropped down to 75% of original value as of the time of the loan?   Does that suggest the plan keeps Pat's individual account invested in the funds held at the time the loan was made and the money loaned to Pat was made available from some source other than liquidating Pat's actual investments in the funds to make the loan?

Unless I'm missing it @Peter Gulia is actually mixing his apples and oranges in the hypo.  If it's a participant directed plan, and Pat takes 100% of his balance as  loan, the only thing left in the plan for Pat is his loan receivable of $100,000 plus interest.  There is nothing to decrease in value due to market swings.

If the loan is a PLAN investment, it is a whole other animal.  If you let a participant borrow 100% (let's say $100,000) and participant is laid off/defaults with a market loss that that now values his account at $75,000, the plan has a loss of $25,000 on that investment after participants account balance is used to offset.

If loans are plan investments, I would heavily favor CRDs over CRLs in this economy.  Let them take their balance out and pay taxes or repay over the next 3 years rather than an iffy plan investment in participants ability to repay the loan.

RatherBeGolfing is right.  I wasn't thinking, and misdescribed the accounting.  (The $100,000 in fund shares would be redeemed to pay the loan proceeds.)

It remains that the unpaid $101,000 loan is income.

9 hours ago, RatherBeGolfing said:

If the loan is a PLAN investment, it is a whole other animal.  If you let a participant borrow 100% (let's say $100,000) and participant is laid off/defaults with a market loss that that now values his account at $75,000, the plan has a loss of $25,000 on that investment after participants account balance is used to offset.

Years ago we switched to treating all loans as self directed investments allocable only to the participant/borrower, even when the rest of the plan is pooled.  This prevents the account balance from dropping below the loan value and does not distort the asset management of the plan by having plan assets tied up in them, (except on a self-directed basis). In times where the investment portfolio outperforms the loan interest rate, only the participant is bearing the opportunity cost of having a lower investable balance for having taken a loan. 

Is there not an issue with having a zero balance to charge for fees?

1 hour ago, QPAetc said:

Is there not an issue with having a zero balance to charge for fees?

What would you do if a participant never deferred and there were no employer contributions?

QPAetc’s point is one a service provider might think about.  Especially if the provider’s fees are charged to the plan and it’s impractical to charge the loaned-out participant’s portion against the accounts of other participants.

EBSA Disaster Relief Notice 2020-01 published 4/29/2020 suspended "no more than 50% of account balance" rule in DOL adequate security regs for CARES Act loans, so as far as DOL is concerned you can do lesser of $100k or 100% of account balance to qualifying participants during CARES Act loan period.

On 4/15/2020 at 3:57 PM, Mike Preston said:

What would you do if a participant never deferred and there were no employer contributions?

Terminate the plan? ??

Let me rephrase.... what would you do if a participant owed fees to the recordkeeper but the participant never deferred (although eligible to do so) but had, for one reason or another didn't have an employer contribution account balance?  Whatever you would do in that case is your guiding light with respect to the fee issue posed.