Must a 401(k) plan offer loans?

My company's 401(k) plan does not offer a plan loan option. Is this something that our plan must offer?

No. A 401(k) plan may, but is not required to, offer a plan loan option.

• If your company decides to offer a 401(k) plan loan option, you should be aware of restrictions imposed by the Internal Revenue Code and ERISA that are designed to assure that loans from the plan are true loans and not disguised distributions. For instance:
• Loan terms must be set forth in a written and legally enforceable agreement;
• The amount of the loan may not exceed the lesser of (1) $50,000 (reduced by previous outstanding loans) or (2) one-half of the present value of the participant's nonforfeitable accrued benefit.
• The terms of the loan must require repayment within five years (ten years for principal residence loans).

Loans must be amortized on a substantially level basis with payments made no less frequently than quarterly. In addition, loans to participants must:

• (1) be available to all participants or beneficiaries on a reasonably equivalent basis;
• (2) not be available to highly compensated employees in an amount greater than the amount made available to other employees;
• (3) be made in accordance with specific plan provisions;
• (4) bear a reasonable rate of interest; and
• (5) be adequately secured.

How are 401(k) loan repayments handled while employees are on military leave? Generally, a loan from a 401(k) plan must be repaid within five years (10 years for loans for the purchase of a principal residence). A loan must be amortized on a substantially level basis and payments must be made at least quarterly over the life of the loan.

However, a 401(k) plan may (but is not required to) suspend an employee's obligation to repay a plan loan during the period of the employee's military service (even if the individual is not entitled to reemployment) without risking disqualification or engaging in a prohibited transaction.

Under IRS final regulations, if a plan suspends loan repayments for any part of a period during which an employee is performing military service, the suspension will not cause the loan to be a deemed distribution, even if the period during which the loan is suspended exceeds one year and even if the term of the loan is extended. However, the employee must resume repayments upon the completion of military service. The loan, including interest accrued during the period of military service, must be repaid in substantially level installments over a period that ends no later than the latest "permissible term of the loan," plus any period of suspension authorized for military leave.

Reprinted with permission. © CCH