How Plan Sponsors Can Better Manage Loans from 401(k) Plans

Since the DOL considers participant loans from 401(k) plans to be plan investments, what considerations should plan sponsors have when permitting such loans? What interest rate should plan sponsors charge? According to a recent article in the Tax Management Compensation Planning Journal, 20% of plan participants take out a 401(k) loan at any one time, and 40% over a five-year period, more often than many traditional investments. Thus, they warrant the attention of plan sponsors. Would you agree, and if so, why? Should plan sponsors only permit loans when they are not likely to diminish the borrower’s retirement income? The same article in the Tax Management Compensation Planning Journal notes that participants default on 10% of loans each year, equal to $5 billion, excluding taxes, penalties and lost earnings, and that virtually all loan defaults occur upon job separation. What can sponsors do to help mitigate these defaults, such as permitting employees who have left a company to continue repaying the loan? What is the impact of a mass layoff on defaults, then, and is there anything sponsors can do in that circumstance to alleviate the defaults? What happens to loans if a company goes out of business? What is loan insurance, and is this something that sponsors should consider? Any other thoughts?