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403(b) Policy Loans' Continued Form 5500 Reporting Problem

Robert J. Toth, Jr.

One of the more intractable issues with which ERISA 403(b) plan sponsors must deal every year arises from the “policy loans” issued by insurance carriers under the 403(b) annuity contracts held under the plans. There is simply no good way to report these loans on the Form 5500, and the newly proposed Form 5500 changes do not address this ongoing gnat of an issue.

A policy loan is a quirky financial arrangement which has existed, literally, for generations in the 403(b) market. They are based upon the insurance industry’s historical practice of loaning money to their policyholders. How they actually work is that the insurance company makes a loan to a 403(b) contract holder in accordance with the same loan rules which apply to any other plan loan under the Code and ERISA, and then reserves an amount under the related annuity account equal to the amount of the outstanding loan. Often, for a number of practical reasons, the reserved amount may actually exceed the amount of the loan. As the loan is paid back, the corresponding amount reserved under the contract is also released. It is considered “borrowing against the policy.”

Compare this to the “plan loan,” which is typical under a 401(k) plan and has growing popularity in the 403(b) market. The plan itself makes a loan to the participant. Technically, the borrowing participant elects to invest its assets in a “loan account,” whose sole asset is the promissory note between the participant and the plan. As the loan is repaid (and funds deposited in other investment accounts of the participant), the value of the loan account decreases.

Here’s the problem: loans are required to be reported on the Form 5500 financial statement, and are carried under the Form 5500 rules as a separate asset of the plan (under the newly proposed 5500 rules, it will be carried as a receivable instead of an investment). This works well for the “plan loan,” as it just shows up as an asset of the plan on Schedule H line 1(c)(8). However, a policy loan is reported much differently. Even though you have taken out a loan, no cash for the loan has ever come out of the plan itself. The funds have come from the insurance company’s coffers.

The reserve amount in the annuity contract related to the policy loan still shows up as an invested asset under the contract (typically reported under line 1(c)(14)). If you actually then report the amount of the outstanding “policy loans” on line 1(c)(8), the result is a double-counting of the loan amount as an asset, and your books will be sorely out of balance.

A plan can’t just ignore the loan, as such policy loans are considered plan loans under the Code. But you can’t report them on the participant loan section of the Form 5500, either, without causing serious accounting problems.

The answer is that few accounting firms know how to deal with it, and the issue is often just ignored-that is, the policy loan is just never reported. I find that the better solution is probably to footnote the loans in the audited financial statement, for large plans, and this seems to fulfill the reporting obligations. But the auditor will need to buy into this.

For small plans, the problem is not as acute. Participant loans are reported as a “specific asset” under Part 1, 3(e), a section which does need to be included in the total assets. IT be interesting to see, however, if policy loans are actually regularly reported here, or just ignored.

It really is a Gordian Knot which we must prove every year can’t be untied.

Robert J. Toth, Jr. is principal in the Law Office of Robert J. Toth, Jr., LLC and is a member of the NTSA Communications Committee.

Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA, or its members.