Loans in 403(b) Plans

Marketplace Issues

Loans are a particularly difficult issue in 403(b) plans. Under the final 403(b) regulations, the IRS imposed plan level requirements on loans. However, 403(b) plans funded with individual annuity contracts and custodial accounts also have contract-level requirements applicable to loans that must be addressed. While many of the requirements are identical, the contract rights attached to the individual annuities and custodial accounts inhibit certain plan level compliance initiatives. Additionally, the rules for loans under Code Section 72(p) apply a single loan limit to all plans of the employer.

Thus, monitoring loan limits must be applied to all plans sponsored by the employer in which loans are permitted.  Caution should also be taken if there is a state plan that permits loans and the participant in a 403(b) also participates in the state plan. The third party administrator (TPA), or if there is none, the employer is responsible to aggregate these loans to make sure that the limits are not exceeded. Traditional practices in the financial services industry have carried over into the 403(b) marketplace as 403(b) products are often securities, and companies treat 403(b) transactions as securities transactions.

This proprietorial approach to interpreting a complex set of applicable laws and regulations has led to some reluctance to modify internal customs and procedures to more standardized marketplace criteria. One of the areas that suffers most from the lack of standardization is the general administration of 403(b) plan loans. For example, some product providers are still requiring “wet signatures” and “signature guarantees” for loan distribution authorizations. These practices result in a lack of standardization and inefficiencies in operations by product providers, TPAs and plan sponsors slowing down the proper and timely access of participants to their funds.

At the first summit in 2009, it was also discovered there was a lack of consistency in basic methodology for calculating loan limits. Because of differences in results from provider to provider and TPA to TPA, there was a request from the attendees at that Summit to develop a loan calculation worksheet that could be used in the marketplace as a standard for best practices for 403(b) and 457(b) plan 403(b) loan calculation purposes.

Accordingly, two worksheets were developed: a 403(b) Plan Loan Limit Worksheet for Non-ERISA Plans and a 403(b) Plan Loan Limit Worksheet for ERISA Plans. Also, an educational piece is included that addresses the differences in ERISA and non-ERISA loan requirements, the requirements for refinancing loans and the rules for the granting of new loans when there is an outstanding defaulted loan. [Important Note: These loan worksheets do not reflect the new IRS alternative interpretation of using the highest single loan balance in the last 12 months in lieu of the aggregate amounts of the highest loan balance in the last 12 months. Refer to the loan procedures to see which one will apply to the plan.]

Best Practices

Because of the proprietorial issues unique to loan processing, it may be difficult to establish uniform acceptable “best practices” for loans in the marketplace. However, there was strong consensus that we should establish goals to which the marketplace should strive. That said…

Plans should allow loans only if there is sufficient administrative support a loan feature under the plan. Except for the statutory requirements and specific plan conditions, loan provisions in the plan document should defer to the contractual language of the loan provisions in each participant’s underlying annuity contract or custodial account to avoid conflict. Those provider differences in requirements for loans from custodial accounts and annuity contracts can be managed at the plan level where any other outstanding loans held by the participant are factored into the single loan limit.

Providers and TPAs also should agree, if possible, to conform to the standardized calculation methodology provided in the 403(b) Plan Loan Limit Worksheet. While this manual is focused primarily on the K-14 non-ERISA 403(b) marketplace, we have included an analysis and worksheets on ERISA loans because so many TPAs and product providers have loan systems and operations that must serve both constituencies.

Some key points:

• The employer’s plan documents should permit loans if the employer has engaged a TPA to administer the loans under the plan and should defer to the loan provisions in the underlying annuity contracts and custodial accounts. For example, one provider’s loan provision might permit borrowing at 50% of the account value, while loan language in another provider’s contract may base available loan amounts on the greater of $10,000 or 50% of the account value, both of which are permitted under Code Section 72(p).
• If the employer’s plan permits loans, then the employer should consider product provider’s policies and procedures when selecting plan providers under their plan document and not permit providers that cannot or are unwilling to conform to standardized procedures and calculations.
• When in doubt as to which party must initiate or sign a form, refer to the Plan Features Grid. For 501(c)(3) employers seeking to qualify for the ERISA Exemption, the employer cannot authorize loans. The employer or a representative can provide factual information about the participant, an account balance, previous loan history and similar factual information, but may not approve or authorize the loan or exercise discretion over plan assets. A data aggregator or information coordinator may be used or the vendors may hire a TPA to provide plan based loan services for ERISA-exempt plans.

The Employer Should:

• Notify providers whether loans are permitted in the plan (using the Plan Features Grid) and whether there are any specific requirements or whether the loan language defers to the contractual language of the annuity and custodial accounts. If certain providers are prohibited from making loans, that should also be noted on the grid.
• Require providers to notify their financial representatives about the inclusion or exclusion of loans.
• Allow loans under their plan only from providers that agree to follow the administrative policies and procedures of the TPA authorized by the employer. Providers refusing to comply should NOT be permitted to grant loans under the plan. Additional signatures or authorizations beyond those required by the TPA should not be necessary.
• Review the information on refinancing loans to determine how the plan will address refinancing and defaulted loans. If the employer wishes to prohibit refinancing and subsequent loans after a default, then the plan should reflect these restrictions and providers should be notified. Otherwise, employers must establish rules for the refinancing of loans, the granting of new loans when there is an outstanding defaulted loan and include those requirements in the agreements with the providers.
• Notify the administrator of any other plan (of the employer) that permits loans that information on outstanding loans must be shared with the party responsible for managing loan limits (either the employer or the employer’s TPA).

The Provider Should:

• Examine the employer’s loan requirements and either agree to conform or agree not to permit loans from the provider’s accounts.
• Communicate those loan requirements to financial representatives that are contracted to work with the specific employer.
• Agree not to require employer signature on loan forms if properly notified that a TPA has been assigned this transactional responsibility.
• Re-evaluate historical practices (suggested securities practices for custodial accounts and internal contract support practices for insurers) for appropriateness in the 403(b) plan environment.
• Providers should also agree to continue to provide loan information on participants to the employer or TPA even if subsequently deselected as a provider.
• Determine if the provider will be making loans from ERISA Exempt 403(b) plans and how routine loan procedures will be modified to accommodate restrictions on employer involvement for loans from such plans. Communicate the changes in procedures to the participants, customer service representatives, servicing representatives and the employers.

In all instances, the adoption of best practices should help meet the goal which is to complete the loan request in a timely manner for the participant who will often have a need that can be met only with the receipt of the loan proceeds. Thus, it is recommended that all parties work in a timely manner to follow directions, obtain missing information, get necessary authorizations and cooperate with one another (TPA, product provider, employer, participant or financial representative) to communicate the problem and resolve any issues.

Bill Fisher is a member of the NTSA Leadership Council, serves as Chair of the NTSA Professional Education Committee, and is Director of Business Development for PenServ Plan Services, Inc.

More information on communicating a 403(b) plan to employees, as well as a host of other topics relevant to running and building your practice, can be found in the Best Practices Guide for 403(b) and 457(b) Plans. Information about the Guide is available here.

For a complete guide to 403(b) and 457 plans, contact NTSA for information on The Source, a reference manual for internal staff, advisory firms, TPAs, broker-dealers, and employers.