Most of us have struggled with the obtuse calculations required to determine maximum participant loan amounts. Perhaps in the future robotic AI Human Resource managers will not have this problem, but until then we all seem to muddle through this occasionally.
The statute, which is not a model of clarity, reads as follows:
[The] loan (when added to the outstanding balance of all other loans from such plan whether made on, before, or after August 13, 1982), [may] not exceed the lesser of—
(i) $50,000, reduced by the excess (if any) of—
(I) 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
(II) the outstanding balance of loans from the plan on the date on which such loan was made, or
(ii) the greater of (I) one-half of the present value of the nonforfeitable accrued benefit of the employee under the plan, or (II) $10,000.
Let’s simplify this a little. First, for the moment, ignore the $10,000 minimum described at the end of (ii) above. That leaves the maximum allowed loan to be no more than the lesser of (1) what I am calling the “$50,000 limit” and (2) one-half of the participant’s account balance.
Calculating one-half of the participant’s account balance is simple. Just divide the participant’s vested account balance by two. The total of all outstanding loans cannot exceed this amount. For example, if a participant has an $80,000 vested account balance and an outstanding loan of $18,000, the participant’s second loan cannot exceed $22,000 ($22,000 + $18,000 = $40,000).
The “$50,000 limit” can be more confusing. If you are dealing with the participant’s first loan, the “$50,000 limit” is, well, $50,000. If the requested loan is not an initial loan, then the $50,000 limit is reduced by the sum of the following:
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The excess of (a) the highest outstanding balance during the 12-month period ending before the second loan over (b) the balance due on the first loan immediately prior to the second loan; plus
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The balance of the first loan immediately prior to the second loan.
Another way to view this is the maximum allowed second loan equals (1) $50,000 minus (2) the excess of the highest balance in the last twelve months over the balance due immediately prior to the second loan, minus (3) the balance of the first loan. Simple enough you may say, but it can get a bit more confusing. Consider the following 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.
In this example, what is the highest outstanding balance for the past 12 months? The plan could determine that no further loan would be available, since $30,000 + $20,000 = $50,000. Alternatively, the plan could identify “the highest outstanding balance” as $30,000, and permit the third loan in the amount of $20,000.
In recent guidance, the IRS said plans can elect either approach. That guidance is not binding, and of course all other loan requirements must be met (e.g., enforceable agreement, level amortization, and five-year repayments, as well as ERISA’s prohibited transaction requirements), but it appears either approach would, for now, be acceptable.
P.S. Now let’s add back that $10,000 minimum. Under the prohibited transaction rules of ERISA, a plan cannot allow participant loans which exceed $50% of the participant’s vested account balance, unless the plan obtains additional collateral outside the plan. For that reason, most employers limit participant loans to no more than 50% of the vested account balance and ignore the $10,000 minimum.
