“Our ERISA 403(b) plan has a loan minimum of $1,000. We have a concern about a significant number of our newer employees borrowing as soon as their account balances reach $2,000, when the loan minimum of $1,000 meets the 50% requirement for borrowing. Recognizing that, borrowing against their retirement plan so early in their careers could have a negative impact on their ability to retire, our plan committee was considering raising the loan minimum to a higher amount, such as $3,000. Can we?”
Stacey Bradford, Kimberly Boberg, David Levine and David Powell, with Groom Law Group, and Michael A. Webb, vice president, Retirement Plan Services, Cammack Retirement Group, answer:
The Experts certainly understand your desire as a prudent plan sponsor to limit loans for participants at a time when, due to compounding, borrowing can have an extremely detrimental effect on their ultimate account balance. For the same reasons that saving early is critical to adequate retirement savings, not borrowing early can be critical to retirement savings as well.
However, increasing the loan minimum is probably not the best course of action here. The reason is, since you are an Employee Retirement Income Security Act (ERISA) plan sponsor, loans must be made available to participants on a nondiscriminatory basis, which means making loans available for nonhighly and highly compensated employees alike on a reasonably equivalent basis. By raising the loan limit, you would be impacting the ability of employees with smaller balances to borrow, and those employees are generally nonhighly compensated. This is the reason why plans generally may not establish a loan minimum in excess of the $1,000 limit which has been expressly permitted by Department of Labor (DOL) regulations. See DOL Reg. section 2550.408b-1(b)(2). It should be noted that, if your plan was NOT subject to ERISA, this would not be an issue. However, for non-ERISA plans it may still be difficult to increase the loan minimum, as that may violate the loan provisions in the underlying annuity contracts or custodial agreements.
The Experts would suggest alternative solutions to addressing the small balance borrowing issue, such as limiting loans to elective deferrals, limiting the number of loans that an individual may take while participating in the plan, and/or improved participant education as to the negative consequences of borrowing early in one’s career on the ability to accumulate retirement savings.
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.
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