SURVEY SAYS: How Can You Stop Participants Taking 401(k) Loans to Pay Bills?

OK, there was a fair amount of sympathy/empathy for the plight of our reader – and what struck me as a surprising amount of “ambivalence” on the issue – but…  

Before we get into the “other” suggestions, let me offer one of my own.  In 2008 I wrote a piece for the “Know How” section of PLANSPONSOR magazine to introduce the concept of the trade-offs a participant should consider in taking a loan—hence, the notion of “borrowing from Peter to pay Paul.”  I’ve dusted it off, and republished it – it’s online at http://www.plansponsor.com/Robbing_Peter_to_Pay_Paul_.aspx

Here’s what other readers had to say – and THANKS to everyone who participated in this bonus survey!:

I advocate a limit of 1 loan per participant, $1,000 minimum, with no ability to refinance the loan.  Any prepayment must be a payment in full and repayments must be done via payroll deduction. I also encourage plan sponsors to consider offering loans for defined hardship purposes only and to not offer both a loan provision and a hardship distribution provision in the same plan.  Those plan sponsors who offer loan refinancing and more than 1 loan per participant are just enabling bad behavior.

Telling employees that it is taxed twice.  Once when paying back with after tax payroll deductions and again when they go to retire and it is back in with their pretax 401k.  No one likes to pay taxes more than they have to.

Nothing has worked.  In fact, our plan instituted a $50 loan fee and we only saw the number of loans INCREASE!!  In the true spirit of “Freakamonics”, guilt has an acceptable price.  Apparently $50.00 is within that range.

Nothing.  Especially in the economic times we have endured the past few years I’ve found that the lower income employees are going to take loans regardless of what you say.  While it’s always been somewhat of an issue we are finding serial loans are becoming even more prevalent and that is of significant concern.  Our Plan only allows one loan at a time and there has always been a few employees who habitually take another loan out as soon as their current one is paid off.  Those numbers have been growing, though, and In most cases they are actually paying off the balance of their current loan to take out an even bigger one.  However, I can’t judge the severity, or for that matter, the justifiability of their needs.  In almost all cases I am not privy to the reasons for their need to initiate loans since they deal directly with the TPA for loan processing.

As Lincoln said; "...some of the people all of the time..." Nothing's going to stop it if it's available. You've done your duty to inform. Beyond that, I'm inclined to ask (from a voice of experience) why it's his/her business, anyway. As with many other decisions, hindsight will again prove to be 20/20.

It might be good to show the financial impact of taking such a loan.  "Bob" took a 401k loan to buy a new car... (show Bob's balance going down...him getting a new car...him having to pay back the loan).  "Sue" chose to leave her 401K alone and save up for a new car... show Sue's balance, which starts the same as Bob's.  Show Sue's balance growing and growing.  At some point, Bob and Sue retire...show how much money each now has in his or her 401K. 

I don't see a way of eliminating the ability now without severe ER implications.  At a prior employer, when we initially set up loans as an option, we limited it to one loan outstanding and fairly severe restrictions on how much could be loaned.  Our intent was to start small and increase it based on need.  We had very few complaints and our communications pounded the theme that plan loans were to be a lender of last resort (you only get one so make sure to use it wisely).

Owner of Company  looks at the loan provision in the company 401k as a positive and good for employee relations. 70% are hourly and now more than ever they find it beneficial to borrow money against their plan to pay bills.

We have the same problem - every week I see employees pay off a loan just so they can take a new one.  We only allow 1 loan at a time and have considered implementing a 90 day wait between the time a loan is paid off and a new loan is initiated.  If you find anything that works I hope you share it with all of us.

Periodic communications and employee meetings may help, but nothing is continually successful.  And though we understand all the negatives with taking a loan...it's that very feature that gives many lower paid employees the comfort level of joining!

What's wrong with taking a loan to pay bills, if the alternative is to run up debt?  Rather than an 18% credit card interest rate, why not pay yourself 5%?  I'm not saying participants should buy stuff and run up their debt, then pay for it out of their 401(k) plan, but if they have the debt, what's wrong with using a 401(k) loan to manage the debt more economically?

Limit the loan available within the 401(k) to one or two loans at a time.  If two are offered, allow one general purpose loan (with maximum repayment of 5 yrs.) and one home purchase loan, but not two general purpose loans.

Having taken a loan from my own 401(k), I'm not sure I would do away with the feature.  I guess one could start off by saying that these monies are for your retirement and not to be used as a savings account or credit card.

Due to the current state of our economy, I don't think this is limited to manufacturing employees. We had a situation where a participant needed to save her house, but the plan limited taking hardship withdrawals as an option only when all other options have been exhausted.  What do you do when you know that if the employee took out a loan, they wouldn't be able to pay it back?  Personally, if the options are "take out a loan to pay bills and eat" or "keep all the money in so that it grows and I can still eat later", I think I'd take out the loan and take care of immediate needs - especially if there are children involved.  Sorry - not helpful.

Holding an employee meeting that walks through the detrimental effects of taking 401(k) loans.  It is truly eye-opening, but you have to include spouses for it to really hit home.

We first explore the need of the participant so that we can better understand their specific situation and help them.  Once we understand the need, we determine if there are alternatives outside of the retirement option to meet their need.  If the participant has to go the retirement route, we educate the participant on both the possible immediate and long-term consequences of taking a 401 (k) loan.  We’ll also discuss tools and resources to help the participant be better prepared and educated for the future.

I have found that people that must take a loan from the their 401(k) are in desperate need of money and I do not attempt to counsel them, other than let them know the fees involved and the tax implications.