Employers have the option to allow their employees to take loans from their retirement plan balances.

The loan plan provision would allow an employee to borrow up to 50% of their vested account balance, not to exceed $50,000 (If the participant has not had a loan within the last 12 months).

The loan provision may encourage employees to contribute to the retirement plan knowing they have an option to use those funds later if an emergency occurs. The benefits of a loan option in a retirement plan include:

1. Employees do not have to prove credit worthiness to obtain a loan.
2. The loan repayments are easily deducted from an employee’s paycheck.
3. There are no early repayment penalties.
4. Typically, loan interest rates are 1% or 2% over prime. The interest rate could be lower than what the employee could obtain through a financial institution.
5. Both the interest and the principal payments are deposited to the employee’s retirement plan account.

When deciding to offer loans in retirement plans, employers should consider the following:

1. Employers establish the loan repayments on the employee’s payroll. An employer is responsible for any administrative error if loan payments are not submitted timely to the participant’s retirement account. Payroll errors could result in the loan defaulting.
2. If an employee is terminated and has an outstanding loan balance, the loan would need to be quickly repaid or the loan would go into default and become taxable (and penalized if the employee is under age 59 ½).
3. When an employee takes a loan from the plan, it can significantly impact their retirement savings goals. The employee may not be able to afford employee deferral contributions while making the loan repayments. If the retirement plan offers a match contribution, the employee would miss out on the match contributions deferrals ceased. When taking the funds out of the market, the overall performance of the employee’s retirement account can be impacted.

Benefits Administrators, LLC can help employers decide whether to offer the loan benefit to their employees. We can discuss the specific needs within your company to help you get to the best decision for your retirement plan.