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February 17, 2009


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Amount borrowed by a participant from his or her vested balance under a qualified plan , 403(b) or 457(b) plan.

Loans are limited to the lesser of  the following:

  • $50,000, reduced by the excess (if any) of
    • the highest outstanding balance of loans from the plan during the 1-year period ending on the day before the date on which such loan was made, over
    • the outstanding balance of loans from the plan on the date on which such loan was made, or
  • the greater of
    • one-half of the present value of the nonforfeitable accrued benefit of the employee under the plan, or
    • $10,000.

Some plans do not permit the $10,000 option, and limit loans to the lesser of 50% of the participant’s vested account balance or $50,000

A loan must satisfy requirements that include the following:

  • They must be made available to all plan participants and beneficiaries on a reasonably equivalent basis;
  • They must not be made available to highly compensated employees, officers or shareholders in an amount greater than the amount made available to other employees;
  • They must be made in accordance with specific provisions regarding the loan as provided under the plan
  • They must be made at a reasonable rate of interest (defined below); and
  • They must be adequately secured (defined below).

Plan loans must be repaid within 5 years  unless the loan is used to acquire any dwelling unit which within a reasonable time is to be used (determined at the time the loan is made) as the principal residence of the participant.

Referring Cite

IRC § 72(p), DOL Reg. 2550.408b-1

Additional Helpful Information

  • If the loan does not meet the requirements of IRC § 72(p), the amount received by the participant may be treated as a distribution
  • Loans must be repaid in substantially level amortization over the term of the loan, with payments made not less frequently than quarterly
  • Interest paid on these qualified plan loans are not deductible
  • Prior to 2002, loans could not be made to owner-employees. EGTRRA removed this restriction for plan years beginning 01/01/2002

  • Reasonable rate of interest: A loan will be considered to bear a reasonable rate of interest if the interest rate is similar to the interest rate charged by lending institutions, when these lending institutions are making loans for the same purpose. For instance, if the loan is for ‘personal’ use or for down payment on a home, the interest rate should be similar or comparable to the interest rate charged by financial institutions in the area. The plan administrator may call a few financial institutions in the area to find out the interest rates that they are charging for loans for the same purpose.
    • The following examples are from the department of labor (DOL)   
      1. Example (1): Plan P makes a participant loan to A at the fixed interest rate of 8% for 5 years. The trustees, prior to making the loan, contacted two local banks to determine under what terms the banks would make a similar loan taking into account A’s creditworthiness and the collateral offered. One bank would charge a variable rate of 10% adjusted monthly for a similar loan. The other bank would charge a fixed rate of 12% under similar circumstances. Under these facts, the loan to A would not bear a reasonable rate of interest because the loan did not provide P with a return commensurate with interest rates charged by persons in the business of lending money for loans which would be made under similar circumstances. As a result, the loan would fail to meet the requirements of section 408(b)(1)(D) and would not be covered by the relief provided by section 408(b)(1) of the Act.
      2. Example (2): Pursuant to the provisions of plan P’s participant loan program, T, the trustee of P, approves a loan to M, a participant and party in interest with respect to P. At the time of execution, the loan meets all of the requirements of section 408(b)(1) of the Act. The loan agreement provides that at the end of two years M must pay the remaining balance in full or the parties may renew for an additional two year period. At the end of the initial two year period, the parties agree to renew the loan for an additional two years. At the time of renewal, however, A fails to adjust the interest rate charged on the loan in order to reflect current economic conditions. As a result, the interest rate on the renewal fails to provide a “reasonable rate of interest” as required by section 408(b)(1)(D) of the Act. Under such circumstances, the loan would not be exempt under section 408(b)(1) of the Act from the time of renewal.
      3. Example (3): The documents governing plan P’s participant loan program provide that loans must bear an interest rate no higher than the maximum interest rate permitted under State X’s usury law. Pursuant to the loan program, P makes a participant loan to A, a plan participant, at a time when the interest rates charged by financial institutions in the community (not subject to the usury limit) for similar loans are higher than the usury limit. Under these circumstances, the loan would not bear a reasonable rate of interest because the loan does not provide P with a return commensurate with the interest rates charged by persons in the business of lending money under similar circumstances. In addition, participant loans that are artificially limited to the maximum usury ceiling then prevailing call into question the status of such loans under sections 403(c) and 404(a) where higher yielding comparable investment opportunities are available to the plan.
  • Adequate security: A loan will be considered to be adequately secured if the security posted for the loan is something that is of equal or higher value of the amount borrowed. The adequacy of the security will be determined by comparing it with security that would be required by a commercial institution, if the commercial made a similar loan.  The participant must also sign a promissory note for the loan.   The participant’s account balance- under the plan- can also be used as security for the loan. However, no more than 50% of the participant’s balance under the plan can be used as security for the loan

Written By

Denise Appleby

Denise is CEO of Appleby Retirement Consulting Inc., a firm that provides IRA resources for financial/ tax/legal professionals. She has over 20 years of experience in the retirement plans field, which includes training and technical consultation.

Denise writes and publishes educational /marketing tools for advisors; available at Denise co-authored several books on IRAs

Denise is a graduate of The John Marshall Law School, where she obtained a Masters of Jurisprudence in Employee Benefits, and has earned 5 professional retirement designations.
She has appeared on numerous media programs, sharing her insights on retirement tax laws.


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