In 2017, the IRS issued two memoranda regarding 403(b) plan loans and how those loans should be administered.
First, in April, the IRS presented two different options to calculate loan maximums under Internal Revenue Code Section 72(p). General loan maximum rules under 72(p) state that for a loan to not be considered a distribution to the participant the loan must not exceed the lesser of:
1. $50,000, reduced by any excess of
- the highest outstanding balance of loans during the 1-year period ending on the day before the date on which such loan was made, over
- the outstanding balance of loans on the date which such loan was made; or
2. The greater of
- half the present value of the vested accrued benefit, or
The calculation of item (1) above was clarified in the IRS memorandum. If the plan document allows for more than one loan outstanding, the highest available loan limit can be calculated in one of two ways. Either will satisfy the requirements under 72(p), but it is important to be consistent in the way this is calculated by the plan.
In order to “prevent an employee from effectively maintaining a permanent outstanding $50,000 loan balance,” the determination of the maximum loan amount can look at the highest outstanding aggregated balance within the last 12 months, or can look at the highest total balance of each loan individually. The following example was provided by the IRS:For example, 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, since $30,000 + $20,000 = $50,000. Alternatively, the plan may identify “the highest outstanding balance” as $30,000, and permit the third loan in the amount of $20,000. At this time, the law does not clearly preclude either computation of the highest outstanding loan balance in the above example.
The second IRS memorandum focused on cure periods. Code Section 72(p) requires a loan to be repaid within five years, unless the loan is for the purchase of a principal residence. The same section also states that loan repayments must be equally amortized with payments being made at least quarterly.
Over the years, questions have arisen regarding missed payments that are beyond the payment period but within the cure period. For example, if payments were being made monthly, but one payment was missed in the middle of the year, would the subsequent payments keep the loan from extending into the cure period, and require the loan to face the tax consequences of a deemed distribution? Also, what affect takes place if the missed payments are made up within the cure period, but outside of the current tax year?
In analysis of these rules, the IRS has made it clear that if a payment was missed, but subsequent payments are made, the future payments would count toward the missed payment first, until the loan payments were caught up. The analysis was the same if the missed payment continued across multiple tax years. For example, if payments were being made monthly from January 2018 through November 2018, then a missed payment occurred in December 2018 and January 2019 followed by payments made in February 2019 and going forward, the payment in February 2019 is within the cure period for the missed payment in December 2018 and would count toward that payment date. In this example, the payments are still behind by two payments, but the payments going forward will allow the loan to not violate 72(p) and will not be deemed distributed.
It is vitally important to note that these missed repayments should still be made up as soon as possible. One option, as stated by the IRS (and if allowed in the plan document), is to refinance the loan. The refinanced loan will still have the same completion date, but will allow the participant to amortize the payments over the remainder of the loan period.
Remember that the repayment of the loan can in no way extend beyond the 5-year period. If the participant is behind on payments, but still within the cure period, it is possible to accidentally extend beyond the 5-year period. This would be an audit failure and would cause the plan to be out of compliance.
Always make sure to maintain proper plan loan documents and oversight of outstanding loans. It is also important to refer to the plan document and investment provider contracts regarding plan loan provisions, loan repayment requirements, and maximum loan calculations.
Nathan Glassey, TGPC, QKA, is Vice President, Non-ERISA Retirement Services.
Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA or its members.