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Are You Computing Participant 401(k) Loan Amounts Correctly?

New guidance on calculating allowable loans if a participant took previous loans during the year

A man and woman using a credit card on a couch.

In late April 2017, the IRS issued a Memorandum for Employee Plans (EP) Examinations Employees providing two alternatives for computing the maximum 401(k) participant loan amount when the participant has prior loans.

The IRS has established rules that allow a 401(k) plan participant to take no more than 50 percent of his or her vested balance up to a maximum of $50,000 in a rolling 12- month period. But before this memorandum, the law was not clear concerning how to compute the maximum loan amount when a participant has taken a previous loan during the year.

As described in the new guidance, the maximum participant loan amount is the lesser of:

  • 50 percent of the participant's vested account balance; or
  • $50,000 less the highest outstanding balance within one year of the loan request.

The reason for adjusting the maximum by the repayment amount is to prevent an employee from effectively maintaining a permanent outstanding $50,000 loan balance. The question is how to compute the amount of the highest outstanding balance within one year of the request for a new loan.

The issue is best described by an example. Assume the following facts:

  • The participant has a vested balance of $150,000.
  • The participant borrows $30,000 in February and fully repays that amount in April.
  • The participant borrows $20,000 in May and fully repays that amount in July.
  • The participant applies for a third loan in December.

What is the highest outstanding loan balance within one year—$50,000 ($20,000 plus $30,000) or $30,000 (the largest loan during the one year period)? What is the highest loan amount this participant can take: $0 ($50,000 less $50,000) or $20,000 ($50,000 less $30,000)?

Until the recent IRS Memorandum, the answer was not clear. The IRS Memorandum answers the question by providing that either amount can be used as the maximum loan amount.

Notably, from the participant's perspective, the $20,000 is a better resolution since the employee can get another loan. Of course, many employers discourage loans and would not want to provide such flexibility.

In any event, whichever approach the plan decides to use, it must be used consistently. In addition, the best practice would be to have the methodology set forth in the plan's loans procedures.

[SHRM members-only toolkit: Designing and Administering Defined Contribution Retirement Plans]

Randal M. Limbeck is a principal in the Omaha, Neb., office of Jackson Lewis P.C. He has spent more than 25 years specializing in the areas of ERISA, employee benefits and executive compensation. © 2017 Jackson Lewis. All rights reserved. Reposted with permission.

Related SHRM Article:

Explain 401(k) Plan Loans’ Upsides and Downsides, SHRM Online Benefits, February 2014 

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