(b)lines Ask the Experts – Requiring Transfer before Taking a Loan

Michael A. Webb, Vice President, Retirement Plan Services, Cammack LaRhette Consulting, answers:    

First of all, let me state that this is a controversial area, since there is no direct guidance on the issue and obviously plan sponsors and inactive vendors have competing interests in this regard; vendors may not wish to see funds transfer to the new vendor, and plan sponsors may wish to permit loans and hardship distributions without the added administration, and related expense, of coordinating such provisions among inactive vendors.    

However, despite the controversy, we can offer some thoughts based on IRS guidance in other areas. In general, the IRS has indicated that the plan should control the contract, not the other way around (see, e.g., Section 5.07 of the proposed revenue procedure published in IRS Announcement 2009-34). Thus, if that guidance could be applied to this specific situation, it would appear that a plan could be written so that loans are only permitted from the active vendor.   

The IRS (in the form of benefits, rights, and features testing under 401(a)(4)) and the DoL (under 29 CFR §2550.408b-1) have both issued guidance indicating that loans must be made available on a nondiscriminatory basis; however, the application of these rules at the plan, as opposed to contract, level would seem to support the position that loans need not be offered in all contracts, as long as the contract(s) in which they are offered are available to all participants. If loans are only available in the active contract(s), such loans would be available to all participants, even terminated participants, assuming that they could transfer their account balance from an inactive vendor to the active vendor(s).    

Where the situation becomes more complicated is where the contract cannot be amended to prohibit loans and does not provide that the plan terms will control; either due to the fact that the contracts with the inactive vendor are individual in nature, or otherwise cannot be amended by the employer. If this is the case, it seems that the plan sponsor can still prohibit loans from the inactive vendor via the terms of the governing plan document, on the theory that the plan document should control, rather than the contract language, and there is no apparent obligation on the part of employer to permit or approve loans under its plan (see, e.g., DOL Field Assistance Bulletin 2010-01, Q&A-14).    

However, the problem is enforcement, especially where the plan sponsor has little control over participant transactions with the inactive vendor.   And the conflict between the plan and contract puts the inactive vendor in the difficult spot of choosing to honor the contract or honor the plan.  The best that a plan sponsor or inactive vendor can likely do in this situation is inform the participant of the possible adverse tax consequences of borrowing from the contract when the plan does not allow loans from inactive contracts and let the participant make an informed decision.    

Again, this is quite a controversial area, so plan sponsors and vendors would wish to seek the advice of outside counsel that is well versed in such issues involving 403(b) plan provisions before proceeding.   

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.