401k Loans – new guidance issued by IRS. 401k Loans can be troubling for 401k and 403b plans with administrators concerned about the burdens and costs to the plan as well as to their participants. Recent IRS guidance has shed new light on how much a participant may borrow and there is new guidance on hardship loans
There is the myth that all 401k loans are bad. Not true. Sometimes participants really need the money and many employees would not participate in the plan if loans were not available.
Best practices discussed at TPSU programs on 401k loans include:
- One loan at a time
- Six month waiting period between loans
- Loans based only on hardship which is verified and administered by the plan’s record keeper
- Default insurance for those involuntarily separated which is why most loans default
- Required online counseling like with student loans
A Michigan based law firm outlines IRS safe harbor guidance about documentation for hardship loans. Even if a plan sponsor outsources the process of verifying documentation for hardship loans, ultimately, the plan sponsor as fiduciary is responsible if the documentation is inadequate. The new IRS guidance allows plans to accept a summary of the documentation supplied by the participant if that participant has received notice about the requirements and agrees to preserve the documents.
Issues arise when documentation proves not to be adequate or if more than two loans are taken in a plan year. The Michigan law firm recommends:
- Expressly limit hardships to no more than two per year;
- Ask your provider whether it is using the actual documentation or summary document process and have them document that process for you;
- Audit a sample of hardship distributions to ensure that the process chosen is being followed and that the hardship distributions are justified by and consistent with the documents or summary provided by the participant; and
- Review and document your review of data or reports provided to you as required under the summary process, if the provider is using that process. This review ideally should be conducted during your regular committee meetings.
