Participant Loans – IRS Requirements

Valuable Information on 401ks, Pensions, ESOPs, Form 5500 Preparation + More

If you participate in your Company’s 401k Plan, you are probably already aware that your Plan may offer an option for you to take out a loan from your 401k balance. These loans are tax free and typically require you to pay your loan back plus interest over a certain period of time. There are a few key requirements that your 401k loan needs to meet to be in compliance with the Internal Revenue Service (“IRS”). These key requirements are as follows:

  • The maximum amount a participant may borrow from his or her plan is 50% of his or her vested account balance or $50,000, whichever is less.
  • Generally, the employee must also repay the loan within five years and must make payments at least quarterly. The law also provides an exception to the 5-year requirement if the employee uses the loan to purchase a primary residence which can extend the loan repayment period to 30 years.
  • If an employee has an outstanding loan and terminates employment, plan sponsors may require an employee to completely repay the outstanding loan balance. If the employee is unable to repay the loan, then the employer will treat the loan as a deemed distribution and will report it to the IRS on Form 1099-R, which means the employee will then need to pay taxes on the distributed loan amount.

In addition to the IRS requirements noted above, each plan can have its own specific loan policy that participants are required to follow. These loan policies may require their own minimum loan balance amount and also limit the number of loans allowed at any given time. Participants should receive information from the plan administrator describing the availability of and terms for obtaining a loan.

By Ryan G. Wojdacz, CPA