“However, I believe the Experts excluded one method of limiting loan utilization from your list of options (see “(b)lines Ask the Experts – Reigning In Loan Use”). Can’t a plan sponsor require that a participant only be able to borrow for a specific reason, such as the categories of hardship required to take a hardship distribution? This provision would significantly limit the number of loans in a plan.”
Michael A. Webb, Vice President, Retirement Plan Services, Cammack LaRhette Consulting, answers:
Though the Experts agree that permitting loans only in the event of financial hardship or some other specified reason is permissible, as a practical matter it is a rare event that we see plan sponsors restrict such loans is this fashion, for several reasons:
1. There is clear guidance in this regard with respect to distributions, but there is no such guidance with respect to loans. Thus, in the event of an audit, there will be a facts and circumstances determination as to whether a hardship or other standard for borrowing was discriminatory or otherwise violated relevant statutes;
2. The use of a hardship or other standard for taking a loan creates an additional administrative burden, and any additional administrative burden also increases the potential for error;
3. Since the law does not otherwise restrict loans, plan sponsors may feel the imposition of such a restriction may be viewed by employees as paternalistic; and
4. If a hardship standard similar to that for distributions is utilized, loans may decrease, but there may be a corresponding increase in the amount of hardship distributions, which, unlike loans, result in a permanent loss of retirement plan accumulations.
Thus, limitation of borrowing to hardship or another specified reason was not included on our short list of ways to reduce loan utilization, though it may indeed be of merit to certain plan sponsors. Our list is by no means exhaustive and no doubt there are other methods that plan sponsors have implemented to reduce loan utilization as well.
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.