Skip to Main Content

Keeping you informed

IRS Says Interest Rate of "Prime Plus 2%" is Reasonable Rate for Participant Loans

    Client Alerts
  • December 02, 2011

During a recent telephone forum discussing participant loans, an Internal Revenue Service Representative stated that the agency generally considers prime plus 2% as a "reasonable interest rate" for repayment of a loan between a plan and a 401(k) participant. Generally,a loan between the plan and a 401(k) plan participant is prohibited under ERISA, unless the participant loan:

  • is made available to all participants and beneficiaries on an equivalent basis;
  • is made equally available to highly compensated and non-highly compensated employees;
  • is made in accordance with plan provisions;
  • is adequately secured; and
  • bears a reasonable rate of interest.

Under the applicable Department of Labor Regulations, a loan is deemed to bear a reasonable rate of interest if the interest rate charged is equivalent to rates charged on the open market by a third party lender.

This new informal guidance from the IRS effectively establishes the current safe-harbor rate for participant loans. In addition, the IRS urged those plans considering a rate less than prime plus 2% to be prepared to prove that the lower rate is equivalent to the market rate. Accordingly, employers should carefully weigh the consequences of making participant loans at a rate less than prime plus 2%, because this may trigger the assessment of prohibited transaction excise taxes, and jeopardize a plan's qualified tax status in accordance with the tax code's anti-assignment provisions.