“Due to concerns regarding overutilization, we are looking to restrict the number of loans that a participant may have outstanding. Any hints from the Experts as to how to best construct such a policy?”
Michael A. Webb, vice president, Cammack Retirement Group, answers:
Absolutely, and congratulations on addressing the issue! Loan overutilization can be a serious matter, both from a compliance perspective and from the perspective of overall participant retirement readiness, since loans erode retirement accumulations.
In attempting to restrict the number of loans that a participant may have outstanding there are many factors to consider, which include, but are not limited to, the following:
- Current loan utilization—What is the average number of outstanding loans per participant? If it is, for example, 5 loans, implementing a restriction limiting the number of outstanding loans to 3 may be more disruptive than, say, limiting outstanding loans to 5. In arriving at a suitable number, one should also look at subsets of the outstanding loan data (i.e., how many participants have 3 or move loans outstanding? 5 or more?) as well.
- Prospective or retroactive? – Related to the above, it is quite different to say to an employee who has borrowed more than 5 times that he/she is limited to 5 additional loans going forward (prospective) or that he/she may not borrow again until the number of outstanding loans is reduced to a number below 5 (retroactive). The former will result in zero short-term impact on loans, but the latter creates more employee relations issues. Despite the employee relations issues, in the Experts’ experience, most plan sponsors have opted for the retroactive option
- Lead time – Some plan sponsors have opted to provide an unusually long period of time (e.g. 4 to 6 months) between the announcement of the loan restriction to employee and the actual effective date of the restriction. Though such time does allow for a “run on the bank”, so to speak, of participants submitting loan requests under the existing rules prior to the effective date of restrictions, again such lead time can address potential employee relations issues.
- Recordkeeper implementation—you need to work diligently with the plan’s recordkeeper(s) to ensure that any loan restriction can be enforced by the recordkeeper(s) to avoid any operational compliance issues. Also, if there are any inactive recorkeeper(s) with assets remaining in the plan, any loan restrictions with respect to those assets will need to be addressed as well, as noted in a previous Ask the Experts column.
Finally, in addition to restricting the number of loans outstanding, you may wish to consider other methods of restricting loans; among other options, an Ask the Experts column suggested limiting loans to elective deferrals only (no employer contributions).
Thank you for your question!
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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