(b)lines Ask the Experts – Best Method for Loan Repayments

May 21, 2013 (PLANSPONSOR (b)lines) – “We are adding a loan provision to our 403(b) plan and are adopting a loan policy as you suggested in a recent Q&A.

“However, we are undecided as to whether loans should be repaid via payroll deduction or by coupon/ACH direct payments by participants. We can permit one or the other, but not both. What say you, Experts?”  

Michael A. Webb, Vice President, Retirement Plan Services, Cammack LaRhette Consulting, answers:  

With the wisdom of Solomon, the Experts say, “It depends upon your goals!” Yes, the Experts realize that is not actually an answer, but both options have their advantages, so it does boil down to what advantages are most important to plan sponsors.    

If compliance is most important to you, payroll deduction may be the preferable choice. The reason for this is that loan repayments are guaranteed, presuming that you do not permit loan repayments to be made after termination of employment. If coupon/ACH direct payment is permitted, it is possible for participants to take loans as a way to circumvent in-service withdrawal restrictions the plan may have, simply by borrowing with no intention of making repayments.

But it can be tricky to match loan deductions precisely to the loan amortization schedules, especially when individuals go on leaves of absence and the amortization schedules change (since, for non military leaves, the initial loan term cannot be extended). Also, if multiple vendors are utilized, there is the added complexity of having to develop an interface with each vendor for loan repayments, all of whom may have specifications that differ from one another.    

If administrative simplicity is paramount, coupon/ACH direct payments may be the more favorable solution. There is no in-house administration of the repayment process at all; payments are handled directly between the vendor and the participant.   

Of course, defaults are possible under this method, though recent loan regulations now essentially prohibit a participant from defaulting on multiple loans via the direct payment method. The reason for this is that, after the initial loan default, a new loan must either a) be secured by outside collateral (which would be rare for a vendor to accept) or b) be repaid by payroll deduction, and your plan would not be permitting payroll deduction in this scenario. Finally, permitting participants to repay loans on their own may be viewed by the participants are less paternalistic.   

Regardless of method, you should make certain that all loans are administered in accordance with your loan policy and applicable regulations. And the Experts wish you the best of luck with whatever path you choose!  


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.