The HCE Who Wants a Loan She Can't Repay
Summit Analytics sponsors a 401(k) plan that permits loans up to the lesser of 50% of the vested account balance or $50,000, reduced by the highest outstanding loan balance during the prior 12 months. The plan requires level amortization with payments at least quarterly and a maximum term of five years. Priya, an HCE with a $120,000 vested balance, already has an outstanding loan of $20,000. She now requests a second loan of $45,000 to buy a house. Her payroll records show her net pay after the existing loan payment is $1,900 per month, and the new loan payment would be about $850 per month. She also has a pending divorce and has asked whether she can simply stop repaying the loan if she leaves the company. The plan administrator wants to approve the loan because Priya is a good employee and the plan has ample assets. The plan document does not permit hardship withdrawals.
1. Calculate the maximum permissible new loan and determine whether the $45,000 request can be approved.
Read the worked answer
Start with the statutory cap: the lesser of 50% of the vested balance ($60,000) or $50,000, reduced by the highest outstanding loan balance in the prior 12 months. The $50,000 limit is reduced by the highest outstanding balance, not the current balance. If the highest outstanding balance during the prior 12 months was $20,000, the maximum new loan is $50,000 − $20,000 = $30,000. The 50% test gives $60,000, so the binding limit is $30,000. The $45,000 request cannot be approved. The administrator also must apply the plan's own loan policy, which mirrors the statute, so the answer is $30,000, not $45,000. Approving $45,000 would be a prohibited transaction and an operational failure.
2. What are the consequences if Priya stops repaying after she leaves, and what should the administrator tell her?
Read the worked answer
A loan that is not repaid according to its terms becomes a deemed distribution, taxable to Priya in the year of default, and if she is under age 59½ the 10% early distribution penalty generally applies unless an exception applies. The plan can offset the loan against her vested balance when she terminates, but the offset is treated as a distribution and must satisfy the distribution rules; a plan may not offset before a distributable event. Priya's divorce does not by itself permit her to stop repaying; a QDRO could assign part of the account but does not eliminate the loan obligation. The administrator should tell her that a default creates taxable income and possible penalty, that she should not assume leaving the company wipes out the loan, and that she should consider whether the new loan payment is affordable given her net pay. The plan should not approve a loan the participant cannot repay, and the administrator should document the affordability analysis.