If you are wringing your hands trying to figure out how you report those 403(b) “policy loans” on the Form 5500 Schedule H, understand that you are not alone-and that there is no easy answer to your dilemma. This problem arises from a continuing flaw in the Form 5500, which the DOL never fixed after requiring 403(b) plans to fully report financials for plan years 2009.

A “policy loan” is an instrument unique in the retirement market to the 403(b) plans. With just a few exceptions, it is the manner in which loans are made by vendors under 403(b) annuity contracts. They are fundamentally based on policy loans from insurance contracts issued in the non-retiremnt market.

Here’s the source of the problem: Typically, for the “plan loan” (of the sort under a 401(k) plan and the 403(b) plan with Custodial Accounts (ether group or individual)) the funds for a loan are actually removed from the participant’s account, and investments are liquidated. What is left in the plan is an account receivable backed by the promissory note, and there are no investments in the plan to report. This matches up well with Line 1(c)8, which requires that the outstanding value of the be included as part of the plan’s financial statement as an asset.

But the 403(b) annuity “policy loan” is much different. The cash from the loan is obtained from the insurer’s general account, and no investment funds are ever liquidated from the participant’s annuity contract. An amount equal to the value of the outstanding value of the loan are transferred to a “restricted” investment held within one of the annuity contract’s investment funds, or in a separate account specially designed to pay a special rate of interest on that investment. The participant has no access to those funds, and the funds are released over time as the loan (with interest) is repaid to the insurer.

The asset statement from the insurer then shows that there is an investment still in the contract, as an asset equal to the value of the outstanding loan. It is earning interest which is reportable on the 5500, and is reportable as an asset of the plan as part of the value of Line 1(c)10 or 1(c)14 of Schedule H. If you then also report the outstanding value of the loan on Line 1(c)8, as you seemingly are required to do, you have double counted the value of the asset, and have an unbalanced financial statement.

Auditors hate this, and they try to address it in a number of creative ways. The problem is that it can’t be ignored: the loan balances, and in particular the defaulted loans, still need to be reported. I find it useful to be reported on the auditor’s report, either as a footnote or separate paragraph. But don’t ignore the issue.

This is not so much a problem for Schedule I filers, for small plans, because the participant loans are reportable on line 3 just as a description of assets in the plan, where it does not need to balance back to Line 2.



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