Understanding 401(k) Loans
The recent enactment of the Tax Cuts and Jobs Act of 2017 (TCJA) makes changes to 401(k) loan repayment options, which should prompt plan sponsors and plan administrators to re-evaluate their existing loan program, processes, and procedures. Although not required by law, many 401(k) plans offer a loan provision as a way for plan participants to access money prior to retirement. The thinking is that more employees will contribute to the plan if they know they can tap into their savings should they incur an unexpected expense while working; conversely, if employees can only access their savings at retirement, employees may decide not to contribute at all.
Rates & Loan Amounts
The loan rate is determined by the plan (i.e., the plan sponsor or plan fiduciaries) and is usually equal to prime rate plus 1%. Plans will often set a minimum loan amount of $1,000 due to the administrative work involved in processing them. The maximum loan amount is usually 50% of the participant’s vested account balance up to $50,000.
While loan rates and minimum loan amounts are fairly consistent across all plans, there is less commonality on the number of permitted outstanding loans. Recent findings from the PLANSPONSOR 2017 DC Survey: Plan Benchmarking reveal that 59% of plans offering loans only offer one loan, 31% offer 2 loans, while 9% offer 3 or more outstanding loans. Offering plan participants the ability to have more than one outstanding loan may feel like a gratifying gesture on behalf of the employer. However, participants may view this as an endorsement by the plan sponsor to simply take a loan whenever money is needed. The Pension Resource Council in 2014 revealed that participants who have access to multiple loans are more likely to borrow in the first place: “This is suggestive of a buffer-stock model also found among credit card borrowers. In other words, given the ability to borrow multiple times, workers are more willing to take the first loan, given that they retain slack borrowing capacity for future spending needs.”
Loan Program Considerations
If the purpose of a 401(k) plan is to help employees save for retirement, it may seem counterintuitive to offer a loan provision, which if utilized, will have a negative impact on the participant’s retirement nest egg. For plan sponsors who feel it’s important to offer access to these funds prior to retirement, make sure you know exactly what is offered in the loan program and that it is the right fit for your plan.
Considering the addition of or modifying your company’s 401(k) plan can seem intimidating or daunting when trying to determine what’s best for your employees. At Gasaway Investment Advisors, we provide full-service administration for defined contribution retirement plans. We accept fiduciary liability and offer plan consulting through regular reviews to ensure the company’s goals are met. Additionally, we provide education and enrollment programs for new participants.
If you find yourself questioning your company’s current 401(k) plan features or would like to provide a 401(k) plan to your employees, we can be reached at (269) 324.0080 for a free initial consultation.