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Qualified Plan Loans – Evil or Essential? – Part 1*

By Jack Towarnicky

On May 22nd in Dallas Texas I will be presenting this topic at the World at Work, Total Rewards Conference.  This is a preview of that presentation.  

Why do so many believe plan loans are “evil” in terms of their impact on retirement preparation? A quick Google search identified more than one hundred articles to document that most of the benefits industry and benefit press believe 401(k) loans are bad. These eight as representative:

  • Custodial Financial: “Future Shock: The Retirement Loan Default Crisis“
  • US News & World Report: “Why You Should Avoid 401(k) Loans:  Experts say a loan can severely undermine investment performance afterword” 
  • Mass Mutual: “Borrowing from a 401(k):  Will Borrowing Crack Your Nest Egg?” 
  • Fidelity:  “Bottom Line on Loans:  Retirement Savings Are Depleted “
  • MarketWatch:  “Why 401(k) loans are far more costly than they seem”
  •  “How to Combat the 401(k) Loan Problem” 
  • The Wall Street Journal: “Advisers Warn Against 401(k) Loans” 
  • CNBC: “Top 10 reasons you should never borrow from your 401(k)”

The presentation will confirm some of the “evils” participants encounter in certain plan loan processing. It is true what we have been told – typical plan loan provisions can be misused.  So, plan loans can reduce retirement savings.  I will review the following facts from those articles and various academic and service provider studies:

  • Borrowers save less           
  • There is a loss of investment earnings 
  • Many plans charge fees on loan processing
  • Loan interest is double taxed
  • Leakage at separation on loan defaults

However, at the same time, when loan administration is "done right" and the service provider embraces 21st century functionality, plan loans can IMPROVE retirement preparation. In fact, for American workers living payday to payday, liquidity through plan loans "done right" IS essential to saving enough for retirement.  You will come to know why plan loans, done right, add value and improve retirement savings:

  • Some borrowers will save more 
  • Liquidity may increase account balances 
  • Interest & fees on plan loans are often less than commercial sources
  • Plan loan interest may qualify for tax preferences
  • Plan loans can reduce leakage

Simply, liquidity practices of the past negatively impacted retirement savings, while 21st Century liquidity strategies, done right, can improve retirement preparedness.  Should you pursue 21st Century loan functionality, successful implementation will be heavily dependent on the enthusiasm and capabilities of your service provider. However, because few plans already incorporate 21st Century loan functionality, you can still be a “first mover.”  Without adding to your plan administrative expense, you can create a competitive advantage. And, because the Tax Cuts & Jobs Act of 2017 and the Bipartisan Budget Act of 2018 made certain changes to liquidity effective in 2019, you’ll want to reconsider your liquidity strategy with respect to hardship withdrawals, now, in 2018.    

Come and see why, depending on plan administration, plan loans may have a dramatically different impact on retirement preparation.  

* This is one of two presentations scheduled for the World at Work, Total Rewards Conference. The other presentation is titled:  The HSA In Your Future:  Defined Contribution Retiree Medical coverage.  Articles on both topics have been published – The HSA in Your Future article was part of the Fourth Quarter 2016 issue of Benefits Quarterly. The Qualified Plan Loans article was included in the Second Quarter, 2017 issue of Benefits Quarterly. After the conference, I will post more details on each topic.  

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