New Loans to Terminated Participants

[MNO]

Does ERISA permit new plan loans to terminated participants who have remaining account balances?  Can you provide the code section if ERISA addresses this topic.

[MoJo]

ERISA doesn't prohibit loans to participants who have terminated employment, but the plan may do so - simply because most employers require loan repayments via payroll deduction (which requires that you be employed) and don't want to mess with receiving a bunch of checks from former employees....

[hr for me]

agree that it will be in the plan document/SPD or loan procedures.  I agree with MoJo that it is NOT a good business practice to allow especially if the former employee could distribute their account.

[MNO]

Thank you, Mojo and hr for me.

[ESOP Guy]

You really want to think through the practical issues before you change a plan to do this. 

How will this person pay the loan back?

if by check do you have a system of tracking and controlling the checks so they aren't lost/stolen when received?

What happens if the check bounces?

How does this cash get transmitted to the trust?

Do you really want to spend all this time and energy for a former employee?

I have seen exactly one plan that did this and they valued their former employees.  It was a very successful management consulting company.  They treated their alumni very well becasue they often times became members of upper management of companies.  This give this consulting company an "in" to generating new business.  Otherwise I have never seen anyone think it is worth it. 

[thepensionmaven]

I agree with ESOP Guy.

We use Datair for our documents and utilize the payroll deduction as the means of repayment.

Obviously if there is a termination of employment, there would be no new loan.

In absence of using this provision, I would check to see if the prior loan payments were timely made, and that there was no previous default.

Since the plan would be on the hook if payments not made timely, I wouldn't bother with this.

[CuseFan]

You can use a third party loan service bureau, such as BPAS MyPlanLoan, to administer loan program that enables terminated participants to continue repaying loans after they leave company - stems leakage, it's a great benefit - as well as potentially allow terminated participants with balances to take (and repay) new loans. This also takes loan administration out of payroll and TPA hands, making leans more automated and efficient - easier for HR/payroll and TPA.

[BenefitJack]

I would bet that you pay at least one bill each month electronically - if only because it is less expensive (new checks, fees, postage, etc.)   

Simply, service providers do participants a disservice when they fail to utilize 21st Century banking functionality on behalf of their 401(k) participants and their loans.  

I mean, who is the plan designed to benefit, anyway?  

Consider this.  Let's say you have a worker who saves for 5 years, from age 25 to age 30.  She is living payday to payday - but for the contribution to a 401(k) plan.  She has an emergency, her car fails, and she has to buy a used car.  She is not credit worthy.  So, she has three choices - max out her credit cards (at 29.99% interest - something she can't afford), take a series of payday loans (at nearly 400% interest - can't afford that either) or take a plan loan (repay in 2 years @ 5%).  She borrows from the plan, reallocates her investments (so that the plan loan becomes her fixed income investment and she has the same investment allocation to equities) and changes her living style - squeezing the loan payment into her budget - without having to reduce her 401(k) contributions and give up the match.  

Should she lose her job, you would deny her the right to continue repaying the loan - forcing leakage?  

Scenario #2:  Let's say she loses her job, gets a new job that requires a significant commute at an employer that does not offer a 401(k).  So, she has to buy a better car.  You would deny her the option to borrow the money - forcing a distribution?  

I thought we put these plans in place for the participants.  I thought the 401(k) was a separate legal entity.  People don't stop their status as participants because their employment ends.  

Long past time for service providers to come into the 21st Century.  See:  2nd quarter 2017 Benefits Quarterly:  Qualified Plan Loans: Evil or Essential?

 

[ESOP Guy]

Ac

5 minutes ago, BenefitJack said:

I thought we put these plans in place for the participants.

 

Actually I thought employers put these plans in place as part of an overall compensation program for their employees.  It make little sense to send money on a former employee instead of the current employees. 

Nice hypothetical, sob story that doesn't represent anything close to a large minority of 401(k) loans much less a majority. 

[BenefitJack]

Certainly, yes, part of total rewards.  But, last I heard, all of the service providers talk about these plans as programs put in place to prepare for income replacement for periods after employment ends.  Both the DOL and IRS have confirmed that you can vary the fees assessed against participants who are no longer employed - if you want to.  In fact, the majority of plan loans are repaid.  And, in fact, the majority of plan loans that default (where assets are not used for retirement) occurs because the plan does not accommodate electronic banking repayment processes - that are prevalent everywhere else in today's economy.  

I could see resistance if the plan sponsor would be paying greater fees.  But, given the lower cost of repayment via ACH (compared to payday processing), and given the IRS/DOL guidance, the only reason why electronic repayment is not more prevalent seems to be because service providers aren't enthusiastic about plan assets that are not generating fees as assets under management.  

There is an opportunity here for the service provider willing and interested in providing greater value - particularly in terms of retaining assets and the associated fees for terminated vested participants.  Remember, the median tenure of American workers is 5 - 6 years.  So, each American will have 6, 7, 8, 9, 10 or more employers.  Lots of opportunity for asset aggregation/consolidation for those who will cater to participant needs.  

[hr for me]

Having been on the tech side of CC payment processing and ACH EFT processing for another hat I wear at our company, it's not that simple for a 401k recordkeeper plan to just decide to take EFTs or CC payments. While it seems "simple" to those who have not researched the circus of these types of payments (vs bulk payments from payroll), it truly isn't.  It requires a whole new set of laws to comply with (PCI compliance etc).  Those fees can add up to 4% of the payment that has to be charged to someone each payment. Are you suggesting that the plan sponsor would charge that fee on top of the loan payment/interest?  And then someone has to reconcile the (daily) incoming payments (one at a time outside of the bulk payroll feed), make sure it is credited to the right person.    Honestly I do this now for a group of 900 customers for one business and 500 at another.  We get daily transactions along with twice a month autobilling AND get chargebacks/declines to deal with.  Unless the employer wants to add a pretty much full time position to their 401k/payroll group, I just don't see any of them wanting to dive into your viewpoint of becoming a bank for terminated employees.

Amortization schedules in 401k plans were just not set up the same way as a regular bank loan.  Plan loans were never meant to replicate loans out in the banking/finance world. It's always been communicated that if you leave employment, you would owe the outstanding balance pretty immediately.  One of my first jobs back in the early 90's was for one of the top 3 HR consulting firms in their 401k recordkeeping department -- I had to audit and "fix" loans where payments were out of whack with their amort schedules. I'm sure it's gotten better, but I don't see where the recordkeeper or plan sponsor should get any deeper into the loan business.

Sad to me that any participant has to rely on their 401k as their only savings vehicle.  Makes me wonder then if the plan shouldn't be checking the credit status if they are to be forced to be a money lender to people who no longer have a direct relationship of payment to the plan from payroll.

And many of the large service providers are getting their fees off of terminated vested participants as they roll their funds into IRAs at that service provider.

But I am old-fashioned and never thought 401k loans were a good idea in the first place....

[ESOP Guy]

13 hours ago, hr for me said:

And many of the large service providers are getting their fees off of terminated vested participants as they roll their funds into IRAs at that service provider.

 

Or the distribution fees which is a place I think one could really complain about. 

I have seen $100 distribution fees in 401(k) plans charged to the participant.  That seems easier and cheaper to get then some loan processing fee on terms.