Under what circumstances can a loan be taken from a qualified plan?

Posted on: July 15th, 2014

A qualified plan may, but is not required to provide for loans. If a plan provides for loans, the plan may limit the amount that can be taken as a loan. The maximum amount that the plan can permit as a loan is (1) the greater of $10,000 or 50% of your vested account balance, or (2) $50,000, whichever is less.

For example, if a participant has an account balance of $40,000, the maximum amount that he or she can borrow from the account is $20,000.

A participant may have more than one outstanding loan from the plan at a time. However, any new loan, when added to the outstanding balance of all of the participant’s loans from the plan, cannot be more than the plan maximum amount. In determining the plan maximum amount in that case, the $50,000 is reduced by the difference between the highest outstanding balance of all of the participant’s loans during the 12-month period ending on the day before the new loan and the outstanding balance of the participant’s loans from the plan on the date of the new loan.

For example, assume Participant A has a vested account balance of $100,000 and took a plan loan of $40,000 on January 1, 2005, to be paid in 20 quarterly installments of $2,491. On January 1, 2006, when the outstanding balance is $33,322, Participant A wants to take another plan loan. The difference between the highest outstanding loan balance for the preceding year ($40,000) and the outstanding balance on the day of the loan ($33,322) is $6,678. Since the new loan plus the outstanding loan cannot be more than $43,322 ($50,000 – $6,678), the maximum amount that the new loan can be is $10,000 ($43,322 – $33,322).

A plan may require the spouse of a married participant to consent to a plan loan.

(IRC Section 417(a)(4))

A plan that provides for loans must specify the procedures for applying for a loan and the repayment terms for the loan. Repayment of the loan must occur within 5 years, and payments must be made in substantially equal payments that include principal and interest and that are paid at least quarterly. Loan repayments are not plan contributions.

(Reg. Section 1.72(p)-1, Q&A-3)

A loan that is taken for the purpose of purchasing the employee’s principal residence may be able to be paid back over a period of more than 5 years.

(IRC Section 72(p)(2)(B)(ii); Reg. § 1.72(p)-1, Q&A-5,-6, -7, and -8)

A plan may suspend loan repayments for employees performing military service.

(Reg. Section 1.72(p)-1, Q&A-9(b))

A plan also may suspend loan repayments during a leave of absence of up to one year. However, upon return, the participant must make up the missed payments either by increasing the amount of each monthly payment or by paying a lump sum at the end, so that the term of the loan does not exceed the original 5-year term.

(Reg. Section 1.72(p)-1, Q&A-9(a))

Loans are not dependent upon hardship. Some plans may provide for hardship withdrawals, however. As long as a plan provides for loans, the purpose of the loan or the participant’s ability to borrow the same amount elsewhere is irrelevant in determining whether the loan is permitted, unlike hardship withdrawals, which require a demonstration of need.

The participant’s relationship to the plan (e.g., being an owner of the plan sponsor) does not affect the participant’s ability to take a loan, as long as all participants are equally able to take loans under the plan’s loan provisions.

Loans are not taxable distributions unless they fail to satisfy the plan loan rules of the regulations with respect to amount, duration and repayment terms, as described above. In addition, a loan that is not paid back according to the repayment terms is treated as a distribution from the plan and is taxable as such.

(IRC Section 72(p); Reg. Section 1.72(p)-1, Q&A-1)

If your 401(k) plan or 403(b) plan has made loans that haven’t complied with plan terms about loans, find out how you can correct this mistake.

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