Benefits and Compensation

IRS Spells Out Two Available Plan Loan Computations

The Internal Revenue Service (IRS) on April 20 clarified the two ways defined contribution (DC) plans can calculate maximum participant loan amounts in a memo that should bring some relief to plan sponsors and administrators.retirement

In a memorandum to Employee Plans (EP) Examinations employees, the IRS said an employer can determine the highest outstanding loan balance in the past year in two ways when figuring the amount a participant can take out as an additional plan loan. One of the Internal Revenue Code (IRC) restrictions on plan loans to participants is that the total amount of loans outstanding may not exceed $50,000 in a year.

Two Exceptions

The memo said that generally IRC Section 72(p) provides that a plan loan is a distribution to the participant. The tax Code provision gives an exception to a loan that does not exceed the lesser of:

  • $50,000, reduced by any excess of the highest outstanding balance of loans during the year ending on the day before the date on which the loan was made, over the outstanding balance of loans on the date on which the loan was made; or
  • The greater of half of the present value of the vested accrued benefit, or $10,000.

This adjustment prevents a participant from maintaining an ongoing outstanding $50,000 plan loan.

Under Section 72(p), if the initial loan is less than $50,000, the participant usually may borrow another loan—if the plan allows this—within a year if the aggregate amount does not exceed $50,000. The $50,000 is reduced by the highest outstanding balance of loans during the 1-year period ending the day before the second loan, which is reduced by the outstanding balance on the date of the second loan.

Example Provided

The agency provided the following example to illustrate the memo’s clarification:

A participant borrowed $30,000 in February, which was fully repaid in April, and $20,000 in May, which was fully repaid in July, before applying for a third loan in December. The plan may determine that no further loan would be available, because $30,000 plus $20,000 equals $50,000. Alternatively, the plan may identify “the highest outstanding balance” as $30,000, and permit the third loan of $20,000. This assumes that to meet other Section 72(p) requirements, the participant has a vested accrued benefit of more than $100,000, and the loan is repayable in 5 years and requires substantially level amortization.

“At this time, the law does not clearly preclude either computation of the highest outstanding loan balance” in the example, the memo said.

The agency tells its agents that they are to determine whether the plan has calculated the “highest outstanding balance” in one of the two ways outlined in the example if they determine that a qualified plan has made two or more loans to the same participant in a year.

If the plan has used one of these methods, the IRS memo says the “requirement under section IRC Section 72(p)(2)(A) is met and no further inquiry need be done.”

The memo applies to exams open on and after April 20, when the memo was issued.

Jane Meacham is the editor of BLR’s retirement plan compliance publications. She has nearly 30 years’ experience as a writer/editor of financial services news.