As reported by BNA Pension and Benefits Daily on December 19, 2012, an Internal Revenue Service (“IRS”) official again confirmed in a December 18 webcast that the Prime rate + 1% may not be a reasonable interest rate under the Internal Revenue Code prohibited transaction rules which apply to loans from qualified plans. We discussed previous remarks by IRS officials some time ago.

In recent years, plan administrators typically set the interest rate for plan loans as the Prime rate + 1% in effect on the first of the month during which the loan is originated (or a similar set date).  The IRS official indicated that there is no safe harbor under the rules for Prime rate + 1%, Prime rate + 2%, or any other rate.  Instead, plan fiduciaries charged with establishing the rate should periodically perform due diligence to determine prevailing rates in the market place for similar loans.  A co-presenter offered that a similar loan should be considered a secured loan, citing a loan secured by a certificate of deposit or other similar property.

What’s on your next 401(k) committee agenda?  Adding consideration of an appropriate interest rate for plan loans is prudent.

Disclaimer/IRS Circular 230 Notice