Loan programs typically are positioned as an opportunity for participants to borrow from themselves and to pay themselves back with interest.
Of course, that rate of interest is typically lower than the participant could earn in the retirement plan—and it has to be paid on an after-tax basis, to boot.
This month’s Know How introduces the concept of the trade-offs a participant should consider in taking a loan—hence, the notion of “borrowing from Peter to pay Paul.”
Most participant-directed retirement programs today offer participants the ability to borrow against their accumulated savings for a variety of reasons, both significant and mundane. It has long—and perhaps rightly—been viewed as an important incentive in encouraging workers to participate in the program.
And, it can do more than that. According to the Employee Benefits Research Institute, on average, a participant in a plan offering loans appeared to contribute 0.6 percentage points more of his or her salary to the plan than a participant in a plan with no loan provision.
Still, taking money from the plan, however temporarily, runs counter to the basic premise of tax-deferred savings. Every day the money is not in the plan, the participant loses ground in saving for retirement. EBRI data indicate that the average unpaid loan balance for participants was 16% of the net account balance—SIXTEEN percent.
In addition, while that same EBRI data suggest that only 18% of those participants eligible for loans had one outstanding at the end of 1996, that study also found that those between the ages of 30 and 59 were more likely to have a loan outstanding than younger or older workers—a savings “gap” at a particularly critical time.
We hope this month’s issue will help you offer your participants an opportunity to balance their current need for cash with their need for cash in the future.
Need to Know:
» The loan requirements of your plan-minimum amounts, interest rate, repayment methods
» How plan investments have fared relative to the "return" on a loan
» Where participants can calculate loan repayments (your provider probably can help)
» Other financing alternatives to suggest for participant emergencies
»What happens if the participant quits?
Read the participant guide "Robbing Peter to pay Paul"