In December, the IRS published guidance in its Employee Plans News publication regarding participants requesting multiple plan loans. Unfortunately, plan sponsors often overlook the requirements regarding plan loans, which can lead to several issues for the plan and its participants, including taxable distributions and operational failures that can threaten the tax-qualified status of the plan. Specifically, plan sponsors often forget to check the plan document to determine whether multiple plan loans are permitted. Additionally, calculations must be performed to determine the maximum amount available to a participant in the event multiple loans are permitted under the terms of the plan. The following example was provided by the IRS:

A retirement plan participant, X, has requested a second plan loan. X’s vested account balance is $80,000. He borrowed $27,000 eight months ago and still owes $18,000 on that loan. How much can X borrow as a second loan? Would it benefit X to repay the first loan before requesting a second loan?

As noted above, X will only be able to take a second loan if the plan allows it. Internal Revenue Code Section 72(p) controls the limits on plan loans and, most of the time, those provisions are incorporated either into the plan or a separate loan policy referenced in the plan. Sometimes a plan may contain more restrictive loan provisions. Therefore, it is critically important to confirm the terms of the plan because any plan loan in excess of the permissible amount is treated as a taxable distribution from the plan.

Looking at the example provided by the IRS and assuming the plan permits multiple loans, the second plan loan, when aggregated with the highest outstanding balance of all other plan loans during the previous 12-month period cannot exceed the lesser of: (1) $50,000, reduced by the excess of the highest outstanding balance of all of X’s loans during the 12 months preceding the day before the new loan over the outstanding balance of X’s loans from the plan on the date of the new loan; or (2) the greater of $10,000 or 50 percent of X’s vested account balance.

As noted above, X’s current loan balance is $18,000. Assuming the highest outstanding balance of all of X’s plan loans over the previous 12 months was $27,000, the maximum amount X could take as a second loan if X still owes the balance on the first plan loan is calculated as the lesser of:

$50,000 – ($27,000 - $18,000) = $41,000 OR $80,000 x .5 = $40,000

Therefore, the maximum amount available to X is $40,000, of which $18,000 is an existing loan balance. This means X can take a new loan of no more than $22,000.

However, if X repays the existing loan before taking out the second loan, there is a different result. Specifically, if X repaid the existing loan ($18,000) before applying for the second loan, X would be limited to the lesser of:

$50,000 – ($27,000 – 0) = $23,000 OR $80,000 x .5 = $40,000 In which case, X could take a new loan of up to $23,000.

Plan sponsors need to be mindful of the limitations set forth in Section 72(p) as well as the specific provisions of the plan document to ensure the issuance of multiple plan loans does not result in taxable distributions to participants and possible plan qualification issues.