Many 401(k) plans offer participants the option to initiate a loan against the amounts accumulated in their 401(k) Plan account. These loans must follow various regulatory requirements including any restrictions imposed by the plan itself or the loan policy administered by the plan sponsor.
Many participants do not understand these loan restrictions. We highly recommend that plan sponsors review these items with each participant during the loan request process to ensure there are no misunderstandings with the employee concerning the transaction. We have listed some of the loan restrictions below.
401(k) PARTICIPANT LOAN RESTRICTIONS
1.) Some plans do not allow additional contributions into the 401(k) plan until the loan is fully paid off.
Of course, this limits the additional funds going into the account as well as the earnings on the investment during the timeframe of the loan. The 401(k) account is provided to help an employee save for retirement.
Having extended periods without contributions reduces the overall effectiveness of this benefit. In addition, most contributions are made pre-tax. Limiting the contributions during the year, increases the overall taxes that must be paid by the employee. Lastly, if contributions cannot be made and the Plan offers a Company match, the match amounts are also lost.
2.) 401(k) plans almost always charge fees to initiate a participant loan.
Employees usually do not understand that these initiation fees will be added to the total amount of the loan. They should be encouraged to research the true cost of the amount borrowed including interest and all applicable fees.
An employee should also compare this loan to other available funding sources to ensure they are paying the lowest overall charge for the funds borrowed.
3.) Most 401(k) plans require loan repayment through payroll deductions.
This means a lower amount in the employee paycheck for the time of the loan. Employees should be encouraged to review their personal budgets to verify they can live within the reduced income after subtracting out the loan and interest repayment amounts.
4.) Studies indicate that 40% of retirement plan participants take advantage of loan offerings and approximately 10% default each year.
Employees should understand that in most cases upon termination of employment the full amount outstanding on the loan becomes due shortly after termination.
If the amount due cannot be repaid within the time period stipulated, the amount becomes taxable to the employee and may also be subject to an additional 10% penalty. This can be a heavy financial burden to an employee already in a bad situation due to the loss of income from the loss of employment.
ALTERNATIVES TO 401(k) PLAN PARTCIPANT LOANS
Plan Sponsors may want to discuss with the employee alternatives to taking out a loan such as:
- Negotiating with creditors first before considering a 401(k) plan loan
- Reviewing rates for a personal loan
- Taking out a home equity loan
As the plan sponsor, when it’s time to audit your 401(k) plan, it’s vital that you hire an experienced auditor to ensure your plan is in compliance. At Anders we specialize in retirement plan audits. We have the ability to offer assistance entirely off-site with little or no distraction to your daily office routine. We also offer flat-fee pricing so there are no surprises on your bill when the job is complete.
To get started, request a free 401(k) audit consultation below or contact the team at (314)-886-7913 to schedule an appointment.All Insights