The Internal Revenue Service has increased its level of scrutiny on the limitations imposed on participant loans from defined contribution retirement plans. Internal Revenue Code Section 72(p) generally limits a participant’s plan loans to a total of $50,000 or half of the participant’s vested balance, whichever is smaller. Additionally, this limit is reduced by the participant’s highest outstanding balance of loans during the calendar year prior to the day any new loan is made. This limit is intended to prevent participants from constantly maintaining a $50,000 loan balance.
In a recent memorandum to IRS Employee Plans Examination employees, the IRS provided two acceptable methods of making this determination, using 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. The plan may determine that no further loan would be available, because $30,000 plus $20,000 equals $50,000. Alternatively, the plan may identify “the highest outstanding balance” as $30,000, and permit the third loan of $20,000. This assumes that to meet other Section 72(p) requirements, the participant has a vested accrued benefit of more than $100,000, and the loan is repayable in 5 years and requires substantially level amortization.
The memo indicates that examiners are to determine whether the defined contribution plan has calculated the “highest outstanding loan balance” in one of the two ways as provided in the example if the defined contribution plan has made two or more loans to the same participant during a calendar year.