Subscriber loans: More to consider than you think
Editor’s note: This is the first in a two-part series on Affiliate Loans. He shares insights and suggestions from Joni Jennings, Newfront’s Retirement Services Compliance Manager.
Should the ability for participants to borrow from their 401(k)s be included in the plan or not? That’s the basic question an employer faces when it comes to loans and the plan, but that’s by no means all an employer should consider, one compliance executive suggests.
Deciding whether to include language in the plan that allows participants to borrow is just the beginning, argues Joni Jennings, Newfront’s Retirement Services Compliance Manager, in “401(k)ology – Participant Loans (Part 1).”
“The decision-making process to include loans in the 401(k) plan often boils down to a basic ‘yes/no’ question when the employer enters into the plan’s adoption agreement,” says Jennings, but after that, many employers don’t drive Continue and then consider the parameters of a loan program – such as B. how many loans a participant can outstanding at the same time, the calculated interest and the minimum loan amount. “These are important compliance and fiduciary matters that employers should consider when deciding whether to include a participant loan program in the corporate 401(k),” she writes.
Observe the rules
Jennings points out that there are three rules that are particularly important when it comes to participant loans.
1. Anti-alienation. Generally, 401(k) plan benefits may only be used for retirement benefits; However, an exception to this rule are participant loans that are secured by a participant’s vested benefits account and are not Prohibited Transactions.
2. Prohibited Transactions. Qualifying plans cannot provide credit to disqualified individuals unless there is an exception to prohibited transactions.
3. Taxable Distributions. Distributions from a 401(k) are generally taxable. However, this does not apply to participant loans from a 401(k) as long as the maximum outstanding loan is $50,000 or half of the participant’s vested balance and the participant repays the loan within five years — although the participant may take longer than that if he or she uses it to buy a primary residence.
The plan document
Jennings suggests that a plan document regarding plan loans include provisions such as:
- Note that loans to participants are allowed;
- It states that plan trustees are responsible for preparing a written credit policy; and
- specific parameters for the loans.
Plan the credit policy
A plan document, Jennings explains, generally includes language stating that loans are permitted by participants’ 401(k)s and a loan policy that sets parameters for them. Such a policy, she says, is a “first line of defense” against failures in participant loans and will help ensure participant loans are properly managed.
A credit policy, Jennings says, is viewed as an extension of a plan document. She points out that this must be done in writing and made available to plan participants. Many practitioners include the plan loan policy in the summary plan description (SPD) or as an addendum to it, she adds.
Jennings suggests that these provisions should be part of a credit policy:
- clarify who is authorized to administer the loan program;
- the permitted loan types;
- the amount that can be borrowed for a loan and what is the minimum loan amount;
- the parameters for loans to be used for a primary residence;
- discussion of how interest rates are determined;
- the collateral used to secure a loan;
- the maximum number of outstanding credits a participant may have;
- whether refinancing is permitted and if so, what options there are;
- application process;
- credit approval and denial processes;
- a requirement that a participant sign a promissory note;
- how a participant should repay a loan; and
- Loan Default and Short Term.
The final result
Jennings urges employers to be aware of the rules and put policies and procedures in place to maintain the program.
It is of the utmost importance, Jennings warns, that plan sponsors meet their responsibility to comply with the legal requirements governing subscriber loans. Otherwise, she warns, it could result in borrowers being taxed and fiduciaries involved in a prohibited transaction.
Next installment: Additional Plan Loan Considerations