SURVEY SAYS: Efforts to Discourage Participant Loans

The majority of respondents (81.8%) work in a plan sponsor role, 4.5% are advisers/consultants and 13.6% are TPAs/recordkeepers/investment managers.

More than six in ten (63.6%) responding readers said their retirement plan uses education or plan design features to discourage participants from taking loans, while 36.4% said it does not.

More than one-quarter (27.3%) indicated their plans do not offer a loan feature—a good way to discourage participant loans. More than four in ten (40.9%) reported that the number of loans outstanding is limited to one, 13.6% said loans are limited to only certain accounts, such as employee deferrals, and 4.5% said loans can only be taken for reasons of substantial hardship.

Although no one said participants applying for a loan MUST attend an educational session first, in “other” responses, readers indicated that they send out information about how taking a loan can affect retirement savings, there’s messaging on the plan website about the effects of taking a loan or when applying for a loan online, a message pops up directing the participant to an education piece. Others said they have a two-loan limit, with one reporting that one of the loans MUST be for a primary residence.

One respondent said, “Participants may only apply for a loan once a year, have to wait 30 days after paying off a loan to get another loan, and the minimum amount of the loan is $500.”

In verbatim comments, several readers advocated for not allowing loans at all in retirement plans, but some pointed out the good things, such as participants paying interest to themselves, as long as they don’t default on the loan. Editor’s Choice goes to the reader who said: “If participants would have taken a loan outside of the plan anyway, at a higher rate, they would have to repay the lender with after-tax money, rather than themselves. So the repaid amount is gone, rather than reinstated in the DC account. It can be a reasonable strategy… IF the participant continues making their usual deferral while repaying the loan, and doesn’t default on the loan if employment ends.”

A big thank you to all who participated in the survey!

Verbatim

I just wrote a newsletter article yesterday urging employees to create an emergency savings account to discourage loans from their 401(k). Taking out $5000 and paying it back over 5 years can cause a loss to the account of over $2600! But maybe with $25 deposit into an emergency savings account the loan can be avoided.

I have a little bit of a hard time getting real excited about participant loans. Our recordkeeper has indicated that they don’t see evidence that participants with loans reduce their 401(k) deferrals. So the only possible detriment is the difference in earnings between the interest rate on their loan (prime + 1% for us) versus market returns on whatever they would be invested in (probably retirement date trust). While there is some reduced return on the loan assets, prime + 1% on a risk-free basis is really not that bad of an alternative. That is just my personal view.

Better not to make it an option.

We don’t discourage loans. Sometimes a loan feature is a good thing.

I wish they weren’t allowed at all

We do have some serial loan takers. Some on our team are stridently anti-loan. But, if participants would have taken a loan outside of the plan anyway, at a higher rate, they would have to repay the lender with after-tax money, rather than themselves. So the repaid amount is gone, rather than reinstated in the DC account. It can be a reasonable strategy… IF the participant continues making their usual deferral while repaying the loan, and doesn’t default on the loan if employment ends.

We have an annual benefits fair and a few articles on our intranet throughout the year, but otherwise there is not much ongoing participant education for the 401(k). Thankfully, I work on the product, so I am very aware of what I should do!

The recordkeepers love the automation; thus it’s too hard to / they won’t attach any supplemental communication in either the online application or with the check.

My current employer makes it easier to take out loans. And with both the CFO and controller with 2 loans, it’s not likely to change anytime soon

I recently watched a presentation by a company who is offering an insurance product that would pay off the loan if the participant was involuntarily terminated. Interesting concept. I’m encouraged that the marketplace is starting to develop strategies to address loan defaults due to termination.

As a TPA, we understand the hassle and burden that plan loans can be, so that was not going to be an option on our plan when we designed it.

I do believe that participants are more likely to start participating if they can access their money via loans. We have also limited loans to prevent people taking out new loans in short order (every month) as their balance increased.