Retirement Plan Loans

Internal Revenue Code Section 72(p) discusses the treatment of loans, their taxability, the common reasons for loan failures and how to fix them under the Employee Plans Compliance Resolution System (“EPCRS”).

To prevent a retirement plan loan from being a taxable distribution to the plan participant, plan sponsors, such as the plan participant’s employer, must ensure the loan administration conforms to procedures contained in the plan document and the requirements of IRC Section 72(p).

IRC Section 72(p) generally requires that qualified plans: (1) offer loans based on an enforceable loan agreement that states the loan terms, (2) limit the amount of the loan to the lesser of 50% of the participant’s vested account balance or $50,000, with the amount reduced by any outstanding balance on other loans, and (3) make sure the participant makes level amortized repayments that completely repay the loan within 5 years, unless the loan proceeds are used to buy the participant’s principal residence.

To avoid participant loan mistakes, plan sponsors should review their plan documents and loan administration procedures to see:

• if there are participant loans available under the terms of the plan,
• a participant is being required to repay loans within 5 years
• repayments are being made in accordance with the loan’s terms
• payroll has been notified to begin withholding the loan repayments.

Many loan failures happen when the plan sponsor fails to initiate the repayment payroll deduction from the participant’s wages or the deduction is inadvertently halted because of an administrative error or a change in payroll providers.

Once a plan loan’s terms or repayments violate Internal Revenue Code Section 72(p), the loan is no longer considered exempt and is treated as a taxable distribution to the participant.

For any questions about retirement loan procedures, please consult an experienced New York tax attorney.