In this podcast, Marcel Weiland discusses retirement plan participant loan errors involving IRS rules governing the loan caps and repayment schedule, the potential consequences of a compliance failure to the plan sponsor and employee, and plan correction.
Speaking of Benefits, this is Marcel Weiland. In today’s episode, we’re going to talk about some of the rules governing participant loans from qualified retirement plans.
A qualified plan such as a 401(k) plan may – but isn’t required to – allow for loans to plan participants. The plan loans will be subject to the requirements of the written plan document and to the Internal Revenue Code.
Internal Code section 72 (p) deals with the taxability of a participant loan while Code section 4975 (d) deals with prohibited transactions rules.
In this episode we’re going to focus on Internal Revenue Code section 72 (p) – the statute that deals with taxability and the limits it sets on the loan amount and repayment schedule.
It’s important to understand the Code’s dollar and time limits. If they’re exceeded, the loan becomes a taxable distribution to the plan participant, even though full payment of the loan is still required.
What are those limitations? Participants may receive a nontaxable loan of up to 50% of their vested account balance not to exceed $50,000.
Say for example, the participant has an account with employer matching and a total balance of $125,000. If the participant is vested in $100,000 of that amount, they may take a loan of not more than $50,000.
The loan, by its terms, must be repaid within five years. Principal and interest must be paid at least quarterly in essentially level payments.
There are exceptions to the IRS time limit and that is for loans used to finance purchase of the borrower’s main home. Another exception deals with leaves of absence.
It’s also worth mentioning that if the loans weren’t made in accordance with the terms of the plan document, the plan sponsor would be facing a plan operational failure.
In one interesting situation involving an operational failure, a participant took more loans than the loan procedures allowed. The loan procedures were incorporated by reference into the plan document. The employee was facing a substantial tax threat. We worked with the IRS to allow a retroactive amendment to the plan to allow the additional loans. Happy enough ending all around.
Speaking of benefits, this is Marcel Weiland.
If you’re concerned about a plan participant loan error or want to know more how the plan loan rules apply to your 401(k), let’s start a conversation.
This podcast is for general informational purposes only. It does not create an attorney-client relationship between Employee Benefits Law Group and the listener or reader and does not constitute legal advice for a specific situation.