401(k) loan

snipped-for-privacy@hotmail.com Posted:

Your academic interest may be satisfied by resourcing

.. and then use their search engine for "401k Plans" ... and you will discover that the operative rules are established by the employer who chooses to set up the plan. (Reference will bring up #424)

A publication for guidance of employers is cited, but the actual rules that control loans from your relative's 401k will be set out in the plan documents, available from the employer in question. That would be the accurate source for details that would apply to those participating in that particular plan.

Bill

I think it is counter-intuitive to think that a publication like Consumer Reports would an unqualified summary of rules that are completely flexible and solely determined by the terms of individual employer plans.

I did better than that. I searched for "401k loan". References pointed me to IRC 72(p), which specifies most of the requirements outlined in the Consumer Reports article. To wit:

1. IRC 72(p)(2)(A) states that the amount of the loan is limited to the lesser of ,000 and the greater of ,000 and 50% the vested balance.
2. IRC 72(p)(2)(B) states the loan must be repayable within 5 years.

I do not find anything specific about the interest rate, but I do find this requirement:

1. IRC 72(p)(2)(C) requires a "level amortization" with payments no less frequent than quarterly.

Apparently that means that each payment has the same amount of principal and interest, in contrast to "mortgage amortization", which is the kind of loan payment that we are used to (e.g. using Excel functions PMT, FV and RATE).

I also looked a 26 CFR 1.72(p)-1. There, I find references to examples of qualified loans "with adequate security and with an interest rate and repayment terms that are commercially reasonable".

I don't know enough about what is "commercially reasonable" to know if this implies what Consumer Reports wrote about the required interest rate, or if perhaps some other IRS bulletins embellish their interpretation of IRC in more detail.

But if I were capable of researching and understanding this myself, I would not be asking for assistance in this forum.

So if any knowledgable person can offer a constructive explanation of or pointer to any requirements about the interest rate, I would appreciate it.

You've already been told where to get that information--the plan. You wind up there anyway if you want the loan, so why piddle around guessing? Also note that Code requirements are limits, not requirements. They're not required to offer loans at all.

One thing hasn't been mentioned. IMO 401(k) loans are a horrible idea. Life rarely plays out the way we anticipated it would, and especially in this economy's atmosphere of uncertaintly, pay close attention to the requirements if the borrower no longer works for the sponsor of the plan. More than one has wound up with a taxable deemed distribution, with premature distribution penalty, and no cash to pay the tax.

yes, the lesser. If the balance is $60K, she can borrow $30K.

The rate is tied to prime as a guide, and while the prime changes, a

401(k) loan is usually (always?) fixed. It's set when the loan is issued. As far as how it's paid back, the excel functions still work. I saw your later post, and the phrase "level amortization" should not throw you off.

The payment is deducted from the paycheck, you *can't* be late.

Phil is right to caution against this. Individual circumstances vary of course, but the worse case scenario (losing the job and having the loan deemed to be a distribution) should be carefully considered. You don't mention anything else about her situation, why she needs the money, what her alternatives are, etc. We'd likely try to council her against the idea.

I'll chime in and say the 401(k) plan administrator is the place to go for most of the details you seek, again, IRS pub regarding this is a guideline, not a final plan document.

Joe