Pros and cons of allowing multiple outstanding loans to a 401(k) parti

[Guest DDDlump]

Can anyone comment on the increased administrative burden (ie. paperwork, calculations, questions from plan participants) on 401(k) plans that offer multiple loans as opposed to those that just offer one outstanding loan? Advantages and Disadvantages??

[bzorc]

I have worked on plans where up to 9 loans were allowed to be outstanding at one time. The advantage is to the participant, who does not have to pay off an outstanding loan in order to get a new loan. The disadvantage is to the company and the TPA. The payroll system would have to be adjusted to handle multiple loan payments. The TPA would have to record all loan payments, make sure they get posted to the right loan, and would have to keep a running 12 month "highest outstanding loan balance" in order to calculate future loanable amounts. However, an advantage to the TPA would be able to charge additional loan set-up and maintenance fees.

Multiple loans, in my opinion, are a pain. One instance I can relate is to the participant, who had 9 outstanding loans at once (with after-tax payroll deductions, I wonder what the take-home pay looked like..), calling to see what loan was the smallest, so it could be paid off, so that another loan could be taken. What a mess....

[Kristina]

I agree with bzorc. When unlimited participant loans are allowed, the participants tend to look at the plan as a savings account and not a long term retirement account. The TPA will spend many, many additional hours determining the maximum amount that may be loaned in this quarter, not to mention the ever present "what if I borrow it over x period or y period" scenarios. Also, these participants tend to know when the employer contribution has been made to their plan and will time their loan requests to coincide with that.

After my experiences with unlimited participant loans, my most liberal recommendation would be one new loan a plan year. One outstanding loan at a time would be more manageable.

[Jon Chambers]

Another problem with multiple loans is the payroll process, and which loan deduction is applied to pay which loan. I've seen instances where first loan is fully repaid, but deduction doesn't stop b/c other loans are still outstanding, and also where a repaid loan stops all loan payment deductions, so remaining loans become delinquent. Of course, there are also the typical wrong payment to wrong loan, and the consolidate all payments into a single payment and let the recordkeeper figure it out type of problems. My advice--one loan at a time only. If a participant really needs more money, on an exception basis, the employer can make a short-term "bridge" loan, the participant uses these funds to pay off the current loan, and then applies for a new loan (be careful with calculation of max available). Participant uses portion of new loan to repay employer, net proceeds are just like a second loan, but there is only one loan outstanding at a time.

[Guest santo1967]

One other administative burden that I have seen in the past is that when participants leave the company while having a loan(s) outstanding and leave their 401(k) balance instead of rolling it over is that sometimes the loans are not deemed because payments are not being made to the loan balance. The plan sponsor tends to overlook the area of loans that are not paid off when reviewing quarterly reports and the TPA, more often than not, will fail to inform the client that they need to notify the TPA that they need to deem the loan afyter a specified amount of time.

[Guest Lora Rosen]

Although this is not an administrative burden, one additional element to consider when allowing multiple loans is the impact on the participant's balance at retirement. It can be substantial. It comes down to the plan's philosophy. Sometimes single loans coupled with the plan allowing hardship withdrawals makes sense and can get the same results; strong participation and good retirement balances.

[Guest Dinah Seisman]

In 86 we adopted loans and attempted to limit emps to 1. The first month 3 people needed more money! Since we were monthly valued, the wait to pay off 1 and take another was 2 months. Our solution was to let them "renegotiate" - in otherwords, internally we used the proceeds of loan 2 to repay loan 1. In 95 we converted to a new recordkeeper and daily valuation. Our new recordkeeper resisted these modified renegotiations, but forcing the payoff of 1 loan to take another was still a hassle and a PR issue. We now allow 2 loans and suffer less criticsm as a result. But 9 loans is crazy, as Plan Sponsors we have made loans sound like the greatest thing since sliced bread - we need to do a better job educating participants about the negative impact loans will have on their ability to retire!

[Jon Chambers]

The problem with Dinah's approach is that the renegotiation may cause the term of the loan to extend past the 60 month IRS maximum (for non-home purchase loans). I've seen plans get into significant IRS audit problems using this approach. That's why my earlier post suggested a bridge loan from the company to pay off the first loan, keeping the second loan as a distinct and separate loan, with its own 60 month maximum term.