Internal Revenue Service Q&A On Participant Loans
HERE ARE SOME INTERESTING INFORMATION RELATED TO PARTICIPANT LOANS FROM THE IRS FREQUENTLY ASKED QUESTIONS
- A participant can borrow up to 50% of a vested account balance, but not in excess of $50,000. If the vested balance is less than $20,000, a participant can borrow up to $10,000. Depending on the provisions in the plan document, a participant may have more than one loan, but the cumulative loan cannot be more than the maximum amount [FAQ #3].
- Repayment must occur within 5 years in substantially equal payments that include principal and interest and must be paid at least quarterly [FAQ#3].
- Loans for a principal residence can be paid back over a period of more than 5 years [FAQ #3].
- Loan payments can be suspended while an employee is performing military service [FAQ #3].
- Loans may be suspended for a leave of absence up to one year, but upon return, payments must be caught up so the loan does not extend beyond the original 5-year term [FAQ #3].
WHAT HAPPENS TO A LOAN THAT IS NOT REPAID ACCORDING TO ITS TERMS?
- The entire balance of the loan is treated as a taxable distribution (a “deemed distribution”). Typically, repayment needs to be made by the end of the calendar quarter following the quarter for which the payment was missed [FAQ #4]. If the default is cured after the deemed distribution, the participant’s or beneficiary ‘s tax basis under the plan is increased by the amount of the late repayments [FAQ #5].
- A deemed distribution is not an actual distribution and is not written off the books until the loan is actually repaid, the default is cured or the loan is considered cancelled. Upon one of those events, the loan is then recorded as a distribution. [AICPA 2010 A&A Guide to Employee Benefit Plans, Section 7.55f]. Consult the Plan Document or loan agreement to determine whether the loan is required to be cancelled upon default, to better understand the accounting.
- Delinquent loans that have not been cancelled are considered to be plan assets [2010 A&A Guide, Section 7.55g]. Accordingly, such loans are not written off as a distribution for accounting purposes until they are cancelled.
- Delinquent loans that have not been cancelled are generally required to be reported on Schedule G, Part I, Schedule of Loans or Fixed Income Obligations, except for loans under an individual account plan with investment experience segregated for each account, secured solely by a portion of the participant’s vested accrued benefit [A&A Guide Section 7.55f]. Consultation may be required with qualified ERISA legal counsel to determine whether the plan is an individual account plan meeting the criteria of CFR 2550.408b-1. Loans not meeting this exception should be included as part of a supplemental schedule in the financial statements.
The rules related to participant loans are complex, so individual facts should be discussed with a qualified professional.
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The information contained herein is not necessarily all inclusive, does not constitute legal or any other advice, and should not be relied upon without first consulting with appropriate qualified professionals for your plan’s individual facts and circumstances.
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