Hardships & Loan repayments

[Brian Gallagher]

I have a participant who took a lon in Oct 2000 and immediately started to make repayments. In June 2001 he took a hardship. He continued to make loan repayments ($1200 since June '01). He recently applied for another hardship.

My r/k system is telling me that he has no eligible hardship. All money in his account is elective deferral and has always been invested in a Money Market fund.

Is there something that says loan repays after a hardship are not available for future hardships? Or is my system flawed?

Any thoughts will be appreciated.

...bg

[Guest LWilson]

Is it possible that any hardship available is "in bondage" because of that loan?

He made a dip into the account through a loan. Add insult to injury because his loan has to be backed up by a vested account balance which represents approximately 50% of his outstanding balance.

Top that off with the fact that whatever he has already taken out in hardship is permanently gone . . .

and it is possible that he has not been able to make 401(k) deferrals because of hardship suspension,

and there you have the perfect formula for "nothing left."

I wouldn't write off the possibility that your software may have a "hardship available" glitch. Certainly, double check with your recordkeeping software client support people . . . but I would guess that he's just tapped out right now.

[Mike Preston]

I can see why loans might be in bondage because of hardships, but not why harships would be in bondage because of loans.

Can you clarify that a bit?

The only thing I'm thinking is possible is that the participant is now eligible for a second loan (we don't know how much the first loan was for or how much is currently in the account), but hardships can only be taken if the participant has fully exhausted their ability to take a loan, either from this plan or another plan of the employer.

[Guest LWilson]

Your recordkeeping system shows the Loan as a plan asset. This is really just an accounting mechanism. The loan account will show a balance, but that balance is not what we'd call "ready cash."

Let's say the participant's account looks like this:

Money Market Fund: $ 5,000

Loan Fund: 5,000

Total Balance: $10,000

The participant may have made payments on his loan, but he really has nothing available for hardship. He has a $5,000 loan balance, and the remaining $5,000 has to support the outstanding loan balance, so there is no hardship available. That's sort of what I meant . . . the true assets - the money in that Money Market Fund - are tied up with backing the loan so the participant can't access any of it for a hardship withdrawal.

[Brian Gallagher]

on our r/k system, we actually sell the mutual funds (in the example above, $5000). so if the participant defaulted on the loan, the funds were already segregated out of his account, so the remaining $5000 would be untouched.

try using a combination of the example above and this:

acct bal $10,000

takes loan $5,000

acct bal: $5,000

repays $1,000 of loan

acct bal: $6,000

hardship: $6,000

acct bal: $0

loan repays: $2,000

acct bal: $2000

shouldn't there be an available hardship of $2k? keep in mind, this is all elective deferral money, invested in a money market. i'm ignoring any residual earnings--they don't amount to much.

[Guest LWilson]

I think you misunderstood my example . . . I was just looking at balances.

So, right, you withdraw $5,000 from the money market to generate cash for the loan and you write the guy a check. Then you create this "artificial asset" called Loan Fund, which now has a balance of $5,000.

The thing is, it's not an asset. It's a liability, and it needs something in the plan representing collateral to support it for as long as it's outstanding.

The collateral is the "real" $5,000 you've got sitting in the plan.

Your participant may not access any money that's acting as collateral.

Once he's made $2,000 in loan payments over and above the $5,000 that's backing the loan balance, then he has $2,000 hardship available, (and his loan fund is now $3,000).

[MGB]

Brian,

He should not have been able to take the 6,000 hardship. At that time, 4,000 of that needed to be kept as collateral for the loan, leaving only 2,000 available for hardship.

By taking the 6,000, what he effectively did was to take 10,000 in hardship, erasing the loan into a deemed distribution and should have been taxed on a 10,000 distribution even though he only got 6,000 cash at that time.

I agreee with the system that he does not have 2,000 available now. I don't know how it was overridden to allow the 6,000 hardship, as it should have blocked that, too.

[Guest F1fan]

The preamble to the 401(k) regulations issued in 1991 do not come to the same conclusion as LWilson and MGB. See part 4.b. of the preamble to Treasury Decision 8357.

[Guest LWilson]

Well, I'll be darned, you're right Tom. I must say, I'm surprised, because it really puts a participant who is in a hardship situation in the first place at a greater financial risk. Nevertheless, it's true.

. . . "any participant who has a vested balance may borrow up to 50% of the present value of the accrued benefit . . . the remaining [50%] is available for hardship distribution . . ."

It looks like MGB, myself, and your recordkeeping system (not to mention, the recordkeeping system we use) use a conservative approach . . . I imagine you have an override provision in your software should you decide to permit the hardship. I would definitely print a copy of Treasury Decision 8357 and keep it in the files if you decide to do so . . .

[Brian Gallagher]

we sold the "$5000" of mutual funds and placed it in a loan suspense fund under the trust; therefore any defaulted amount would be pulled from there. thus, the participant would have the $6000 in h'ship available (after $1000 loan repay)

[Guest LWilson]

I gotta say Brian, your firm's approach is interesting. I didn't pick up on the additional "suspense" aspect of the loan distribution when you mentioned it the first time. That's a nice little hedge for a participant who terminates prior to paying off the loan . . . but, that money in suspense IS part of the participant's account balance . . .

and based on the Treasury Decision Tom mentioned, it can actually be included in what's available for the participant's available hardship.

[Mike Preston]

I think the $2,000 is available for a hardship, unless there is some portion of that $2,000 which can be borrowed. The regs make it clear that you can't take a hardship if there is a loan available, from this plan or any other.

I see no reason to "double" secure the loan. The loan is fully secured by the potential of a default. The only potential for loss, before the regs came out, was if a participant defaulted and the interest on the loan ate up the remaining account balance. Now that interest stops accruing when a loan is defaulted, there is absolutely no need to provide for additional security. One might even argue that the code (Section 72) might be changed to eliminate the 50% rule, but that isn't going to happen any time soon.