IRS Scrutiny of Plan Loans Increases, but IRS Provides Helpful Guidance

The Internal Revenue Service (“IRS”) has increased its level of scrutiny on the limitations imposed on participant loans from defined contribution retirement plans. Internal Revenue Code (“IRC”) Section 72(p) generally limits a participant’s plan loans to the lesser of: $50,000, or 50% of the participants vested account balance. Additionally, if the participant already took out a loan within the past 12 months or has an outstanding loan, the highest outstanding loan balance from the past 12 months must be subtracted from the dollar amount that the participant would otherwise be eligible to withdraw for a loan (i.e., subtracted from the lesser of $50,000 or 50% of the vested account balance). This means that even if the loans are fully repaid, the highest outstanding loan balance in the 12-month period still limits the amount the participant can borrow. These rules are a mouthful. That is why the IRS has attempted to clarify how they work by providing an example in two recent memoranda from April and July, as well as a podcast in September: Assume Bob, a plan participant, has a vested account balance in his employer’s 401(k) plan of $120,000. Bob borrowed $30,000 in February of 2017, and fully repaid this loan in April of 2017. Bob borrowed another $20,000 in May of 2017 and repaid this in full in July of 2017. Bob wishes to take out a...

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