2 Easy Ways to Help Fix Your Plan's Loan ProblemSubmitted by BCR Employer Plans on June 28th, 2017
A loan is an easy way to access money. Sometimes, too easy. In many cases, rather than taking loans for emergencies, participants take loans for things or “toys” such as boats, bikes, and trips. While it’s important to monitor your 401(k) plan’s loan activity, plan sponsors must also understand the reasons that employees take loans from their 401(k) account and teach employees why it is important to save appropriately rather than continuing a bad habit.
A 401(k) plan is specifically designated for retirement. A loan should be considered a last resort and/or for emergencies only. The IRS has made this clear with the 10% penalty for pre-59.5 years of age withdrawals. But, with a loan, a participant avoids this 10% penalty. Does this make it okay to take a loan? No. The consequences of taking a loan are probably more severe than a quick 10% penalty on top of taxes but have a slower, longer-term effect.
Here are two ways you can reduce loans in your plan:
1. Educate your employees about the overwhelming downsides to taking a loan
Just because loans may be available to your participant doesn’t mean that it is a wise option. Many plans will restrict a participant from making further contributions to their account until a loan is paid off. Even if the plan doesn’t have this restriction, it would be tough for someone to repay a loan AND contribute to their account. Time and the compounding nature of investing will not work in the employee’s favor. Teach your employees why short-term saving is just as important as long-term savings. Living outside of one’s means can be dangerous.
2. Change the loan process to require company pre-approval
Talk to your plan provider about adjusting the loan process to allow for the company (usually an HR professional) to sign off on loan requests. In most cases, a participant can easily request a loan either by logging into their account on the computer or by picking up the phone. If a loan form must be approved, you will:
a) Accumulate data on the reasons your employees are taking or trying to take loans
b) Make them start to think more about the validity of the request since they have to report the reason to you
Think tough love. Employees know that, in most situations, loans are not a good decision. Make a loan more mentally difficult for a participant to obtain.
The ultimate goal is to help, not punish your employees. While a loan may appear to be an easy solution for a financial problem or roadblock, it can be detrimental to the success of their retirement over time. If your plan allows for loans, it will be hard to eradicate outstanding loan balances, but by following these two steps, you will see that loan requests and overall outstanding loans will decrease.