Qualified retirement plans must be very careful about lending plan assets. Loans from a plan to a disqualified person is generally a prohibited transaction under Code Section 4975 (a “PT”). A disqualified person includes the plan sponsor, so a loan by a plan to the employer (or by the employer to the plan) is a prohibited transaction subject to excise taxes.
However, there is a PT exemption for loans from the retirement plan to a plan participant or beneficiary, if certain conditions are met (a “Participant Loan”). The basic requirements for a Participant Loan are:
- Nondiscrimination. Participant Loans must be available on a reasonably equivalent basis to all participants and beneficiaries.
- Security. There must be adequate security for the Participant Loan. Specifically, they may not be made in an amount in excess of $50,000 or 50% of the participant’s account (whichever is less). In some cases, if permitted by the terms of the plan, collateral other than, or in addition to, the participant’s account balance may be applied.
- Repayment Period. Participant Loans may not be made for a period longer than 5 years, unless the it is for the principal residence of the participant, in which case a longer, but still reasonable, repayment period may be offered.
- Rate of Interest. The plan must charge a commercially reasonable rate of interest, commensurate with the interest rates charged by persons in the business of lending money under similar circumstances.
- Level Amortization. Payments must be made pursuant to a level amortization schedule with payments made at least quarterly. There are exceptions for leaves of absence.
- Written Loan Program. There must be a written loan program, either included in the plan document or through a separate loan policy.
If the exemption requirements are not satisfied, the loan is prohibited and is subject to the excise taxes under Code Section 4975, which can become significant, as the reportable PTs multiply with each passing year.
So, if contemplating any type of loan involving qualified plan assets, plan sponsors must make sure that the loan meets all of the requirements for the Participant Loan exemption, and if it does not, then stop right there and go no further. If in doubt, seek legal benefits counsel to review the proposed loan transaction.