Reconsidering Plan Loans During the Pandemic

Limiting plan loans from has come into sharper relief during the COVID-driven economic turbulence. A recent blog post suggests that there are many aspects of plan loans that are especially advantageous to participants at this time. 

In “Should Retirement Plan Sponsors Be Limiting Plan Loans?,” an entry in Cammack Retirement’s “Top of Mind Blog,” Cammack Vice President Mike Webb admits that he is “not a fan” of plan loans being used too much, but does aver that the regulations governing plan loans “clearly provide” much flexibility in the approaches plan sponsors can take to plan loans. 

But, Webb writes, the insights that Plan Sponsor Council of America (PSCA) Research Director Jack Towarnicky shared in a Cammack podcast led him to reconsider his opinion. “Jack reminded me that plan loans are actually transactions that can be quite beneficial to a participant,” says Webb.

The reasons for that include: 

• Loans are preferable to distributions. If a participant takes a distribution before age 59½ the tax penalties can be heavy; however, if that participant takes a loan, he or she suffers no such tax penalty and “owes” the money to himself or herself. In addition, a loan does not result in money permanently leaving the plan. 
• Interest and charges. When one takes a loan taken from one’s plan, one does not owe interest and charges to some other institution or source from which a loan was secured. 
• Long-term effects. Statutory rules prevent participants from borrowing heavily early in the life of their accounts. It is likely that a participant who takes a loan has significant retirement savings, so a loan is less likely to badly damage an account balance. 

Still, Webb writes, Towarnicky argues that even with the flexibility a plan sponsor has in making plan loans possible, a plan sponsor should be mindful of participants’ financial behavior and help them to control the impulse to borrow—for instance, through financial wellness education or by setting limits on the number of outstanding loans a participant may have. Furthermore, a plan sponsor should make sure participants know that they will still have to repay the loan in the event of bankruptcy—it is not the kind of debt that can be discharged in such a circumstance. “Participants should be educated on the fact that the last place they should borrow from is a retirement plan, if they are financially insecure,” writes Webb.