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The Upside of 401k Loans

 

Loans in defined contribution (DC) plans like 401ks and 403bs are generally frowned upon by experts and plan sponsors but they are available in a majority of these plans to provide a safety valve for employees who might otherwise be reluctant to join. The payroll and benefits administrator at a 180-person law firm attending a TPSU Program at Queens University in Charlotte, NC describes why she is bullish on loans which seem to be working for her company.

The Charlotte law firm incorporates some of the best practices for loans suggested by TPSU plus a new wrinkle. Only one loan is allowed at a time plus employees can only take loans from their contributions, not the company match, which encourages them to contribute in the first place. They do not limit the reasons for the loans but the administrator thought that would be a good idea.

They like loans because it can be a sound financial decision if, for example, the employees wants to buy a house or pay down high interest student loans or credit cards. Part of the law firm’s comfort level with loans is that only 10% of employees use them with just $200,000 of the over $20 million outstanding compared to a national average of around 20%.

But one of the issues with loans is when the unforeseen happens. 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.

Eliminating loans in DC plans might not be realistic but most of the damage and headaches can be avoided by following best practices which include:

  1. No more than one loan at a time
  2. Waiting period of at least six months between loans
  3. Hardship loans
  4. Limiting loans to employee contribution
  5. Required education before loans are taken just like with student loans
  6. Insurance for those that are involuntarily separated which will pay off the loan
Fred Barstein

Fred Barstein

Founder & Editor-in-Chief at 401kTV | TRAU | TPSU
Fred Barstein is the Founder & Editor-in-Chief of 401kTV. Fred is also the Founder and CEO of The Retirement Advisor University (TRAU), a collaboration with UCLA Anderson School of Management Executive Education and The Plan Sponsor University (TPSU).Mr. Barstein was also Founder and Editor-in-Chief of NAPA Net.
Fred Barstein
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