Employee Benefits-IRS Provides Guidance On Interest Charged On Plan Loans

In Retirement News for Employers (Winter 2012), the Internal Revenue Service
(the “IRS”) provided guidance on interest charged on plan loans. Here is what the IRS said.

What is a Reasonable Interest Rate? When a retirement plan allows loans to plan participants, that loan is an investment of plan assets and must bear a reasonable rate of interest. According to the Department of Labor (“DOL”), a plan’s loan interest rate is reasonable if it is equal to commercial lending interest rates under similar circumstances (DOL Regulations section 2550.408b-1(e)). To determine if a participant loan interest rate is “reasonable,” ask these questions:

— What current rates are local banks charging for similar loans (amount and duration) to individuals with similar creditworthiness and collateral?

–Is the plan rate consistent with the local rates?

Three examples are offered.

What are the consequences of not using a reasonable loan interest rate? Unless a reasonable rate of interest is assessed, participant loans may result in a prohibited transaction (see DOL Regulation section 2550.408b-1(a) and Internal Revenue Code section 4975(c)(1)(B)). As a result, the loans would not:

–meet the requirements of ERISA section 408(b)(1)(D);

–be covered by the relief provided by ERISA section 408(b)(1); and
–meet the prohibited transaction exemption for participant loans in IRC section 4975(d)(1).