Coordinating plan loans and hardship distributions.

Coordinating defined contribution plan loans with hardship distributions can provide participants with greater access to funds in their accounts.

Generally, plan loans secured by a participant's account balance in a defined contribution plan are limited to 50% of the participant's total vested account balance (disregarding the $50,000 ceiling and the $10,000 floor restriction under Sec. 72(p)). (See Department of Labor (DOL) Regs. Section 2550.408(b)(l(f).) Under IRS and DOL regulations, all the vested account balances maintained on a participant's behalf under a plan can be combined for this purpose. A loan can be disbursed from an individual account up to the full vested portion of that account (i.e., not limited to 50% of the account's vested portion). This allows loans to be focused on accounts that are not available for hardship distributions, thus maximizing the total amounts accessible by participants. Consistent with this disbursement procedure, the plan would also provide that the security for each loan is to be allocated to each separate account to the same extent that the account supported the actual loan disbursement.

Example 1: Participant P has two accounts in Plan A: a 50% vested company contribution account with a $10,000 balance, none of which is available for hardship distributions; and a 100% vested Sec. 401(k) elective contribution account with a $15,000 balance, all of which is available for hardship distributions. In this situation, P could be allowed to borrow a maximum of $10,000 from the plan - that is, 50% of his combined vested account balances. Using coordination to achieve maximum accessibility, a 10,000 loan would be disbursed in the amount of $5,000 from P's company contribution account (the full vested portion of that account) and $5,000 from the Sec. 401(k) account. This would still leave $10,000 in the Sec. 401(k) account available for hardship distribution so that, if necessary, P could have access to a total of $20,000 out of combined account balances of $25,000 and combined vested account balances of $20,000.

If disbursement of the loan were limited to 50% of the vested account balance for each separate account, P could have received a loan of $2,500 from his company contribution account and $7,500 from his Sec. 401(k) account, with corresponding security from each account. This would have left him only $7,500 for hardship withdrawals from the Sec. 401(k) account, resulting in access to a total of only $17,500.

A note of caution is in order regarding withdrawals or hardship distributions from defined contribution plan accounts that are not fully vested. Generally, the only nonvested account in such a plan consists of company contributions (e.g., across-the-board or matching contributions). Although most plans prohibit in-service withdrawals or hardship distributions before such company contribution accounts become fully vested, some plans do allow in-service distributions from the vested portion of a partially vested company account. If an in-service withdrawal or hardship distribution is made from a partially vested account, the plan must maintain a separate formula for computing the participant's vested interest in the account when he terminates employment. This formula is similar to that used under Sec. 411, which deals with reemployment of terminated participants who previously received a cashout of their vested benefit (the formula that is used instead of the buy-back rule).

Example 2: Participant P, who is 40% vested in his company contribution account of $1,000, makes a $400 inservice withdrawal from that account. Three years later, P terminates employment. At that point, he is 70% vested in his account, and the remaining $600 in the account has grown to $1,000. P's vested benefit must be computed under one of the formulas previously referred to. The simplest formula would take the $1,000 in P's account at his termination, add back the $400 previously distributed to him for a total of $1,400, multiply that by his new vested percentage of 70% for a result of $980, and then subtract the $400 that was previously distributed to him, leaving a net vested benefit of $580 at his termination date.

Plans that allow in-service withdrawals or hardship distributions from nonfully vested accounts should expressly include one of the formulas for recomputing a participant's vested benefit on his subsequent termination of employment. Plan administrators or recordkeepers should also be advised of this rule so they can properly compute vested amounts on such termination.