(b)lines Ask the Experts – Reining in Loan Use

December 17, 2013 (PLANSPONSOR (b)lines) – “Our 403(b) plan appears to have a loan utilization problem: Many more loans are taken on our plan than in those of our peer institutions and there are also a far greater amount of defaults. What can we do?”

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

The Experts agree that overutilization of the plan’s loan feature is a common problem in retirement plans that is often exacerbated by economic conditions. Not only can participants substantially reduce their retirement savings with multiple loans, there can be unanticipated consequences as well. And, of course, the greater number of loans outstanding or in default, the greater the potential of the IRS discovering errors in the administration of such loans upon audit.

But what is a plan sponsor to do? Some sponsors have eliminated loans altogether, but this appears to be a drastic step for most sponsors, since loans are a popular provision that have come to be accepted by plan participants as a desirable plan feature. However, short of eliminating loans, there are a number of actions that plan sponsors can take to address loan utilization and loan defaults:

1.       Improve communication of the loan provision to participants. Is every participant who borrows truly aware of the tax consequences of the loan, as well as the impact on their retirement plan balance and thus the ability to retire in a timely fashion? Is the fact that these issues are exacerbated by taking out multiple loans addressed? Too often, loans are highlighted in vendor communications as a desirable provision of the plan with little emphasis on the disadvantages of borrowing. Plan sponsors should work with their recordkeepers to provide loan communications materials to participants that balance the advantages and disadvantages of borrowing.

2.       Consider implementation of payroll deduction or automatic checking account deductions for loan repayments. Both methods would dramatically reduce the number of loan defaults.

3.       Consider limiting the number of loans outstanding to three or less.

4.       Consider limiting the number of loans that may be taken in a 12 month period to one.

5.       Consider restricting borrowing to a certain contribution type, such as employee elective deferrals only.


By implementing some or all of these suggested actions, plan sponsors can keep the number of loans in their retirement plans from spiraling out of control. Of course, plan sponsors should work with their plan vendors to insure that any new loan provisions can be successfully implemented on the plan’s recordkeeping platform(s).


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.