Plan loan regulations.
The Department of Labor (DOL) has recently issued final regulations on participant loans from qualified retirement plans. The regulations include some expected provisions and some surprises.
Under ERISA, a plan is generally prohibited from lending money or extending credit to parties-in-interest. An exemption is provided to permit loans to participants, who are generally treated as parties-in-interest, if certain conditions are met.
The final regulations define the scope and the specific conditions of the exemption and are generally effective for participant loans granted or renewed after October 18, 1989, except for the risks relating to specific plan provisions (which apply to any loan granted or renewed on or after the last day of the first plan year beginning on or after January 1, 1989).
In order to meet the exemption under ERISA for loans to participants, a participant loan program: * Must be made available to all participants on reasonably equivalent basis; * Must not be made available to highly compensated employees, officers or shareholders in an amount (or percentage) greater than that made available to other participants; * Must be made in accordance with specific plan provision; * Must provide for loans with a reasonable rate of interest; and * Must require adequate security. The regulations expand upon these requirements and provide examples to clarify their application.
Reasonably Equivalent Basis
Plan loans will be considered to be on a reasonably equivalent basis to all participants and beneficiaries, provided certain conditions are satisfied. Loans must be made without bias to nationality, race, religion, etc., and the granting of loans should be based on factors considered by a normal lending institution (i.e., applicant's credit worthiness and financial need). Also, loans may not be unreasonably withheld from any applicant.
A loan program for participants may establish a minimum loan amount up to $1,000. The DOL has established a "safe harbor" and any minimum exceeding the $1,000 could result in non-compliance.
Many employers were concerned that the regulations will allow former employees to participate in loan programs. Plans typically require participants to pay off their loans when they separate from service. However, a recently published DOL Advisory Opinion provides that a participant loan program would not have to be made available to most individuals who have separated from service with vested benefits or who are retirees, because those individuals would not generally be parties-in-interest under ERISA. However, the IRS has stated that the DOL Advisory Opinion that allows certain former employees to be excluded from plan loan programs could result in discrimination under certain proposed Treasury regulations.
Highly Compensated Employees
Participant loans may not be made available to highly compensated employees, officers, or shareholders in an amount greater then the amount made available to all other employees.
Specific Plan Provisions
The regulations provide detailed written requirements that a loan program must meet. Any loan granted or renewed on or after the last day of the first plan year beginning on or after January 1, 1989 (December 31, 1989 for calendar year plans), must be governed by the provisions in the plan or in a written document forming part of the plan which includes, but is not limited to the following: * The identity of the person or position authorized to administer the loan program; * A procedure for applying for loans; * The basis on which loans will be approved or denied; * Limitations, if any, on the amount and types of loans offered; * The procedure under the loan program for determining a reasonable interest; * The types of collateral which may be used in securing the loan; and * The events constituting default and the procedures which will be taken to preserve plan assets in the event of default.
The DOL has indicated that this is not a complete list and applicable documents should be sufficiently complete to inform all borrowers of the procedures of the loan program. Although the plan document must specifically authorize the plan fiduciaries to establish a loan program, the other requirements and procedures listed above may be included in a separate written document referred to by the plan. The regulations further provide that the specific provisions describing the loan program must be included in the Summary Plan Description (SPD) (or, presumably in a supplement to the SPD, such as in the form of procedures).
Reasonable Rate of Interest
The regulations provide that a loan will be considered to bear a reasonable rate if the interest rate provides a return commensurate with the rates charged under similar circumstances by lending institutions. Plan administrators need to conduct the same type of inquiry that would be prudent prior to making any other type of investment. Basically, the DOL would like plan administrators to act as loan officers of lending institutions.
The examples included in the regulations indicate that in determining a reasonable rate, the plan administrator should contact local financial institutions in order to determine the rate charged by such institutions on similar loans. The regulations do not appear to provide support for determining a rate based on an independent market index, a practice common among plans, unless such rate would be consistent with that charged by local lending institutions. Note, however, that the preamble appears to allow more flexibility, provided a plan is administered on a nationwide basis.
The regulations indicate that a participant's vested accrued benefit may be used as security for a loan only to the extent that such benefit can be used to satisfy the participant's outstanding loan in event of default. However, no more than 50% of a participant's vested accrued benefit may be used as security for a loan. This applies to small account balances as well. Thus, plans may not be able to utilize the $10,000 floor for nontaxable loans in the IRC without requesting additional security.
The requirement that the plan have the ability to foreclose on the security interest in the case of default does not apparently require that the plan have the ability to foreclose immediately upon default. For example, in the case of a Sec. 401(k) plan, where in-service distributions are prohibited (other than for hardship) prior to the attainment of age 59 1/2, the plan may foreclose when the individual would be eligible for distribution at age 59 1/2.
Practitioners have to make certain that plan loss programs comply with these final regulations, both in operation and documentation.
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|Title Annotation:||participant loans from qualified retirement plans|
|Author:||Vitucci, John N.|
|Publication:||The CPA Journal|
|Date:||Apr 1, 1990|
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