Disadvantages to Allowing Loan Repayment or Initiation After Termination

“I read with great interest your recent Ask the Experts column on why many 403(b) plans allow participants to repay or initiate loans after termination of employment. However, that column did not mention any risks or other disadvantages to plan fiduciaries in allowing such loans. Does that mean there are none?”

Charles Filips, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, senior financial adviser at CAPTRUST, answer:

Most plan features do have their advantages and disadvantages. Having said that, the reason the Experts failed to mention any disadvantages in that column is that such disadvantages are relatively minor, which is why many 403(b) plan sponsors have been able to offer loans to terminated employees for decades without increased fiduciary liability.

However, the Experts will note a few potential disadvantages of offering such loans, as follows:

1) It will presumably increase the number of terminated employees who remain participants in the plan, as some of these individuals may take a loan rather than a plan distribution. As we know, the longer a terminated employee leaves their account in the plan without seeking a distribution, the more likely they are to become a missing participant over time. However, the added engagement of the loan repayments should make it less likely for these particular terminated employees to go missing, and at any rate, the recent Department of Labor (DOL) guidance in this area should help to ensure that plan sponsors have a decent handle on addressing the missing participant issue.

2) Loans are among the most complicated transactions in a retirement plan. Thus, any plan feature that encourages loans and related repayments could increase the possibility of loan-related plan defects. However, loan overutilization is primarily an issue with active employees rather than terminated ones. Further, other loan features, such as limiting the number of loans that a participant can have outstanding at any one time, can minimize the chances for loan defects.

3) Permitting post-termination repayment of loans could mean increased administrative concerns if the plan does not otherwise permit repayment by check or electronic transfer.

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.

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