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Misleading Plan Sponsors Regarding Plan Loans Hurts Participants – Part 2

05/23/2019
By Jack Towarnicky

Don’t try to insulate participants – they themselves must be financially responsible, accountable.

As a plan sponsor, do you have misgivings about offering plan loans? In the first of two posts, I challenged benefit professionals to a debate over the reasons some use to encourage plan sponsors to limit or avoid liquidity via plan loans.

In this post, here’s my second challenge – I believe the real reasons plan sponsors agree with proposals to curtail or eliminate plan loans include:

  • Pension plans should not be a source of liquidity, and
  • A concern that a few, some, too many participants will misuse liquidity.

News flash No. 1: Your 401(k) or 403(b) plan may be your plan for workers to financially prepare for retirement, but it is not a pension. Only a minority of your workers will actually retire from your firm because the median tenure of American workers has been and continues to be less than five years.1 And post-separation, pre-retirement payout provisions are “banked into” most plan designs. Remember that the participant (not the plan) is the “loan officer” who makes the loan decision. The participant occupies both roles – the borrower and the lender.

News flash No. 2: A handful of workers won’t take full advantage of your plan. Some will fail to enroll (or opt out when automatically enrolled). Some will fail to save enough (or waive automatic escalation). Some will save only to borrow and then default. Some will save anticipating in-service and/or hardship withdrawals (especially after you/Congress liberalized the rules).

Hint: Why would plan sponsors who are so concerned about plan loans continue to offer in-service and hardship withdrawals?

These are challenges every plan sponsors faces. Your workforce is financially diverse. Some are financially illiterate. For most, plan loans offer efficient, low-cost liquidity. Because of the repayment structure, most workers successfully repay loans so long as they remain employed. Because the same repayment structure has a major flaw, most loans default at/after separation.

For those who live paycheck-to-paycheck, plan loans may be their only readily available source of credit. For participants who are in debt and perhaps not credit worthy, liquidity via plan loans may be the one feature that enables them to contribute monies which could not otherwise be prudently set aside for a “far off in the future” retirement. Most savers appreciate the sacrifice they already made to “save up” (in terms of current consumption) – they are circumspect about frittering away accumulated assets.

Remember that liquidity via plan loans, done right, is of unique and specific value to those who don’t believe they can afford to save for retirement, and for those term-vested participants who don’t have access to penalty-tax-free withdrawals.

Debt “Projection”
Oh, the humanity of it all! With a few exceptions, each of us remembers a time when we tussled with the debt demons.

One part of you gently tugs in the “right” direction – rational, sentient. Be a responsible, accountable adult: stop and think about your future before financing a purchase, why not “save up” before you buy? Avoid frivolous expenditures. Stop digging when you find yourself in a debt hole.

Another part of you pulls, drags you off – your limbic system demands enjoyment and enjoyment NOW! Just one more purchase. I haven’t maxed out all my cards. Look, low-cost financing. Retirement is far off, and I’ll never be able to retire anyway. I’ll start saving next week. Or, this purchase is an “investment” – debt financing a car, a bigger home, a college education.

As a plan sponsor, you don’t want to give a brand new shovel to workers who are already in a financial hole. But if your decision on plan loans includes projecting your own personal experiences with debt, remember that every decision to borrow becomes a debt that you will owe to your future self.

Here is my personal debt experience. I first “saved up” so my 401(k) account became the “Bank of Jack.” I knew any plan loan was borrowing from my future self – Jack the future retiree. I took a couple of plan loans. The interest rate I paid was always greater than the return I would have received on other fixed income investments; at the same time, the interest rate was much less than the rate I would have paid on commercial debt. So, every time I borrowed, knowing I would repay the loan in full, I improved my family’s preparation for retirement and our household wealth. That is, I used the plan loan provisions to benefit Jack while employed and Jack as the future retiree.

As a plan sponsor, remember to adjust your plan loan processing so that it will always and repeatedly confirm to participants that they are solely in control of their financial future. Plan sponsors are ill-equipped to successfully insulate workers from making bad financial decisions.

Make sure the participant signs the loan application in two places – where she applies for and where she approves the plan loan. Remind her that she needs the approval of two “bank officers” – the participant today and the participant as a future retiree.


1C. Copeland, Trends in Employee Tenure, 1983–2018, EBRI, 2/28/19, Accessed 5/18/19 at: https://www.ebri.org/content/trends-in-employee-tenure-1983-2018

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