Loan Insurance
At many TPSU programs, plan sponsors complain bitterly about employees taking loans from their defined contribution plans. These plans are set up to be retirement, not savings accounts. But without loans, the fear is that fewer people would participate and loans may be better than hardship withdrawals. When employees leave their job, loans have to be paid back or fines and taxes are incurred. A new service from Custodia Financial that companies can include in their DC plan will pay back the loan if the separation is involuntary.
Almost 20% of DC plan participants have an outstanding loan and 40% will take one over five years accounting for $6 billion in defaults annually. When leaving a job, 86% default on the loan either through neglect or because they don’t have the resources to pay them back. The defaulted loans are considered withdrawals with fines and taxes taking a huge toll.
Custodia Financial offers insurance normally paid for by participants to pay off the loans when employees lose their job involuntarily or upon death or disability. The plan’s record keeper needs to get involved to administer payments and receive paybacks on the loans to streamline the process for plan sponsors.
Loans can help get more participation in a plan as revealed by a plan sponsor attending a TPSU program at Rice University; an employer at another TPSU program at Stonehill College told how a loan not only helped an employee pay her apartment security deposit but got her to start contributing to the plan. Companies should rely on their providers to do the loan administration and deploy the following best practices:
- No more than one loan at a time
- Criterial for taking out a loan (hardship)
- Wait period of 6-12 months after a loan is repaid
But involuntary separation, death and disability could cause defaults and severe financial damage to people which is where the Custodia Financial insurance comes in. Worth investigating – ask your record keeper or advisor about it.
