Borrowing Limits for Participants with Multiple Plan Loans

Background

Internal Revenue Code (“IRC”) section 72(p)(2)(A) sets forth limits on participant loans from a qualified retirement plan. A plan may permit a participant to take multiple loans provided that:

1. Each loan satisfies the repayment requirement of IRC section 72(p)(2)(B), which generally requires that loans be repaid within five years with the exception of loans for the purchase of a primary residence,
2. Each loan satisfies the level amortization requirement of IRC Section 72(p)(2)(C), which requires that payments be made at least quarterly, and
3. The total amount of all loans to the participant do not exceed the IRC section 72(p)(2)(A) amount limitation as discussed below.

Limits on Loan Amounts

A qualified retirement plan may, but is not required to, provide for loans. If a plan so provides, the plan may limit the amount that may be taken as a loan to an amount less than the regulatory limit provided that it is set forth in the plan document. However, the maximum amount that can be borrowed at any time from a plan cannot exceed the maximum amount provided under IRC section 72(p)(2)(A).

IRC section 72(p)(2)(A) provides that the amount of a participant loan, when added to the outstanding balance of all other loans from all plans of the employer, may not exceed the lesser of the following:

1. $50,000, reduced by the excess, if any, of (i) the highest outstanding balance of plan loans during the one-year period ending on the day before the date on which the loan was made over (ii) the outstanding balance of plans loans on the date on which the loan was made, or
2. the greater of (i) 50% of the present value of the participant’s vested accrued benefit or (ii) $10,000.

Note: For purposes of this calculation, an employer’s plan includes the plans of all members of a controlled group of employers, of trades and businesses under common control, and of members of an affiliated service group. More details on controlled groups can be found by accessing our whitepaper.

The regulations under IRC section 72(p) provide that, in general, a participant who has an outstanding loan that does not exceed the maximum amount may borrow additional amounts if the plan document allows for multiple loans and under the facts and circumstances the loans collectively satisfy the limitation on amounts and the prior loan(s) and the additional loan(s) each satisfy the requirements for the maximum loan term and at least quarterly repayments.

To determine the maximum loan amount, the $50,000 limit is reduced by the difference between the highest outstanding loan balance of all of the participant’s loans during the one-year period before the loan is made and the outstanding loan balance of all the participant’s loans at the time the new loan is made. In addition, the adjusted maximum loan amount is further reduced by the current outstanding balance of loans on the day the new loan is made. The loans cannot exceed the lesser of that amount or the greater of 50% of the participant’s vested accrued benefit or $10,000.

Loan Refinancing

Under the regulations, special rules apply to a loan refinancing. In a refinancing, the prior loan is replaced by a new loan. A participant may wish to do this in order to take advantage of a currently available lower interest rate. The loan that is replaced is treated as repaid at the end of the transaction. The loan being replaced is called the replaced loan and the new loan resulting from the transaction is referred to as the replacement loan. For purposes of the maximum loan amount (as discussed above), both the replaced loan and the replacement loan are treated as outstanding at the time of the refinancing if any portion of the replacement loan has a later repayment date than the replaced loan; i.e. the term of the loan is extended beyond the original term.

Calculation of Maximum Loan Amount

For purposes of the following examples it should assumed that the plan permits loans up to the statutory limits and, where implied, also permits multiple loans.

Example 1: Calculation of the maximum amount of loan when there are no prior loans

• Sally’s vested account balance is $125,000. Sally can borrow $50,000.
• Joseph’s vested account balance is $15,000. Joseph can borrow up to $10,000, even though this amount exceeds half his vested account balance.

Example 2: Calculation of the maximum amount of loan when there are prior loans

• Mark has a vested account balance of $200,000 and took a loan for $40,000 on August 1, 2016. On December 1, 2018, when the loan balance is $25,000, Mark wants to take another loan from the plan. The loan balance on December 1, 2017 was $32,000. The maximum amount that Mark can borrow is $18,000. This is calculated by first determining the repaid loan amount for the one-year period before the loan was made, which is $7,000. This is the difference between the highest outstanding loan balance for the one-year period ending on December 1, 2018 ($32,000) and the outstanding balance on the day of the loan ($25,000). The $50,000 limit is reduced by the repaid loan amount to $43,000 ($50,000 - $7,000). Therefore, the maximum amount of the new loan is the reduced limit minus the outstanding balance on the day of the loan, which is $18,000 ($43,000 - $25,000).

Example 3: Calculation of the maximum amount of loan when the prior loan was for $50,000

• Leah received a loan on March 1, 2018, for $50,000, with amortization made on a quarterly repayment schedule. Assume the outstanding balance on September 1, 2018 was $35,000, because she paid extra amounts towards the principal. The repaid loan amount for the one-year period before the loan was made is $15,000 ($50,000 - $35,000). Therefore, the $50,000 loan limit is reduced to $35,000 ($50,000 - $15,000). As the adjusted maximum amount ($35,000) is the same as Leah’s outstanding balance on September 1, 2018, Leah cannot receive an additional loan on September 1, 2018.

Note: If a balance of $50,000 existed at any time during the prior one-year period, a new loan is not permitted, even if the prior loan was completely repaid.

Conclusion

In situations in which they are approving plan loans, plan sponsors should understand how the maximum loan amount available to a plan participant is calculated to ensure that violations of IRC section 72(p)(2)(A) do not occur. If the plan sponsor is not required to approve loans, they should ensure that the third-party record keeper is appropriately limiting loans to participants as the plan sponsor is ultimately responsible for the plan’s compliance with the rules.