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Retirement Plan Loan Rules Becoming Flexible

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Retirement Plan Loan Rules Becoming Flexible

Retirement plan loan repayment rules are getting looser at many companies. Rather than to force departing employees to follow retirement plan loan repayment rules requiring them to pay back their loan balances in full upon separation of service, more employers are allowing them to pay them off in installments.

This is a relatively new retirement plan loan feature, but a growing trend. In 2018, 43% of employers allowed former employees to continue making retirement plan loan repayments vs. 13.3% in 2016. Plan sponsors view their willingness to be flexible when it comes to retirement plan loan repayments as a logical choice. In other words, if it can be done, why not do it?

One benefit of permitting retirement plan loan repayments by former employees over time rather than in a lump sum when they leave the job is that it prevents many participants from defaulting on their loans. Flexible retirement plan loan repayment arrangements thus improve retirement readiness, because loan defaults erode participants’ savings. Most companies that adhere to traditional retirement plan loan repayment arrangements require departed employees to repay their loans within a 60- to 90-day window. However, participants usually default because they are unable to meet these stringent retirement plan loan repayment requirements.

The consequences can be dire. In addition to defaulting on their retirement plan loan repayments, participants must pay federal and state taxes on outstanding loan balances, plus a 10% early withdrawal penalty if they haven’t yet reached age 59 1/2. Worse yet, many are forced to cash out the entire balance of their retirement accounts in order to satisfy their retirement plan loan repayment obligations. This has the potential to severely derail their long-term retirement savings goals.

A very large number of ex-employees default on retirement plan loans when they leave employers, and the majority don’t have the money to pay back the loan in full within a two- to three-month period. In fact, one study found that 86% of employees who have outstanding 401(k) loans when they leave an employer default because their employers require payment in full. Retirement savings losses can be significant for participants. According to recent data from Deloitte, $2.5 trillion in potential future account balances will be lost due to retirement plan loan repayment defaults from 401(k) accounts over the next decade.

As such, extending the retirement plan loan repayment arrangement beyond a former employee’s termination date seems to make a lot of sense to many employers.

Employers such as Hilton Worldwide Holdings, Home Depot, and United Technologies are reaping multiple benefits from extending flexible retirement plan loan repayment arrangements to former employees. These include helping employees preserve their retirement savings, plugging plan leakage, and retaining plan assets — something more plan sponsors are looking to achieve. In fact, almost 70% of plan sponsors seek to retain participants’ assets.

Offering employees such flexibility when it comes to retirement plan loan repayments gives the employee the opportunity to make their retirement plan account balances whole while continuing to use the plan to build their savings for the future. In addition, many plan sponsors view flexible retirement plan loan repayment arrangements as an easy feature to add to their plan. It’s also one that enables more plan sponsors to act in their participants’ best interests — an obvious win from a fiduciary perspective.

Steff Chalk

Steff Chalk

Managing Editor at 401kTV
Steff C. Chalk is Executive Director of The Retirement Advisor University, a collaboration with UCLA Anderson School of Management Executive Education. Steff also serves as Executive Director of The Plan Sponsor University and is current faculty of The Retirement Adviser University.
Steff Chalk
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