Loan programs typically are positioned as an opportunity for participants to borrow from themselves and to pay themselves back with interest.
Illustration by Wesley Allsbrook
That rate of interest, however, is typically lower than the participant could earn in the retirement plan (depending, of course, on the period of time in question, and the relevant interest rate), and it has to be paid on an after-tax basis, to boot.
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 (the thought being that participants are more likely to participate if they know they have some emergent access to their plan assets).
Moreover, in situations where the loan is repaid, where their regular retirement plan contributions are not reduced (at least no more than they might have been to repay a loan taken from a source outside the plan), or where the loan interest rate is lower than that payable to a commercial source, the participant’s overall financial situation might even be improved (note also that, in a perfect world, the participant would reallocate the retirement investment portfolio to reflect the nature of the loan holding as a fixed-income investment).
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.
Although not every participant takes advantage of the option, many do, and according to the 2011 PLANSPONSOR DC Survey, the number of participants with outstanding loans is growing, showing perhaps some increased need for participants to access their savings. Plan sponsors reported that an average of 16.2% of participants had outstanding loans in 2011, an increase of 31.7% of the 12.3% average in 2010.
On the pages that follow is an attempt to outline the implications of taking a loan from one’s retirement plan in a manner directed to participants. We hope it helps you—and your participants—make a choice that represents a good balance of their current need for cash with their need for cash in the future.