SCAM - Loaning deferral monies to participants? Have you seen this!

[Erik Read]

Okay - let's talk about this - has anyone seen this?

Participation Loan

I stumbled upon this site while doing a search, and just could not believe that someone would actually try to get this established in our country. Talk about taking advantage of people.

The most interesting portion is in how the "interest" is calculated, and the fact that the formula does not incorporate losses that a participant may incurr.

Let's beat this up, and make everyone aware of some of these scams in the market.

[Tom Poje]

cute.

so if the people at Enron used this program, not only would they be out their deferrals, but if the match was company stock, they would be out that, plus they still have to payback the loan and interest.

if something is too good to be true you know it is.

[GBurns]

The site mentions that the loan is unsecured and that there is a "No-Loss Guarantee".

Carefully, used as they suggest, it seems that the risk could be on the Lender not the employee.

I have only juggled some basic figures but so far I see no problem with the basic mechanics. However, there could be problems with the terms and conditions etc. in a particular case.

In any case its viability, assuming that it is legal, seems to be a case by case determination.

Regarding Enron, it seems that an Enron employee using the "No-Loss Guarantee" would be no worse off. In addition, using a default against an unsecured loan would also have made them no worse.

[Guest rmeigs]

This thing has been around for years now and hasn't gone any where so far -- which is the way it should be. I don't like the idea. It is just one more way for an ill-informed participant to get in over their head.

[GBurns]

You are right. I did not realize that it has been around for almost 6 years. There still seem to be a lack of investors or distributors.

[Tom Poje]

the number juggling...

suppose someone defers $1000. That $1000 is actually pre tax $ so, using 20% withholding, the person actual is borrowing $1000 on $800. If the person withdraws the $ early then there is an additional 10% early withdrawal tax, so now you are down to $700, yet paying interest on a $1000 loan! you had better have a good match, and better be 100% vested before entering into something like that. But of course, this 'loan' is aimed at the people who are not deferring - generally the lower paid, those who probably won't be 100% when they quit, and those who would take there $ and be subject to the 10% penalty.

[actuarysmith]

Tom beat me to the punch. I was "number crunching" and came to the same conclusion. This would only seem to work with a very generous matching program.

Maybe a safe harbor 401(k) would be a good candidate. Otherwise the withdrawal penalities would eat up all the benefits to taking a loan in the first place.

[Erik Read]

My take of the example is that it works best with a 1 for 1 match and for the individual that cannot afford to defer in the first place (low-income) as metioned in Tom's response.

I don't think the goal was to capture any deferral - and if you end up having to pay 100% of that back, that would be acceptable - I think their goal is to get at the "free" money in the match, and grab what you can there.

WHAT about vesting though - I don't know many plans that do 1 for 1 matching that don't have a 6 year grade attached. So now they're really losing money........

Anyway - I know it's been around, but I didn't see any prior posts and figured it was worth posting so everyone can see it.

Thanks for the comments.

[Guest EAKarno]

This idea seems much better suited to nonqualified deferral plans with a generous employer match. You would be dealing with much larger deferral amounts, more sophisticated borrowers, and far more likelihood of 100% vesting.

[mbozek]

After checking the web site I have one Question : who is the fool? The lender or borrower? The lender is the fool if an unsecured loan is made under these circumstances because the plan assets cannot be pledged to pay back the loan. The lender will not know when a distribution is made or whether the assets have declined because of market conditions or in service withdrawals. Even if the loan is secured by a lien to the residence it will be junior to any mortage loans the owner has which will eat up whatever equity there is. If the borrower is married the Lender who becomes a judgment creditor would be come a co owner with the spouse on an illiquid interest and would see the lien extinguished if the employee dies first. In a community property state the spouse owns 50% of the plan assets.

Is the borrower the fool: The interest rate is probably well in excess (12%+) of the rate of return on the contributions so the employee will not achieve any favorable arbitrage between the interest rate owed to the lender and the rate of return. In addition the cumulative weight of the total of the periodic loans to make contributions will eventually become prohibitively expensive for the employee to amortize which cause a default and maybe a bankruptcy. Isn't this similar to borrowing the annual increase in the cash value from a LI contract - eventually the cost of the interest charges plus the repayament eliminates almost all proceeds due upon death. But in this case the cost of repaying the principal plus interest plus the taxes due at distribution will result in the employee owing money to the lender. Thus the only persons who will take advantage of this product are those who have no intent to repay the loan and are judgment proof ( e.g. dont own any assets that can be seized such as ss benefits) or own Enron stock.

I dont think any reputable financial planner would recommend this product to a client.