I saw a defaulted 401k loan from earlier this century (sounds cool to say that) and thought Paulie Walnuts was going to walk around the corner and start asking me for the weekly payment for "protection"...
More on that after the jump. For now, let's review your role as a HR pro regarding 401k Loans.
Where's your head as a HR pro on the wisdom of 401k loans? Do you talk to employees who are asking about the procedure about the downside of the 401k loan, or do you zip it and consider it none of your business? How does your responsibility as a fiduciary come into play? Does that responsibility mean you speak up or shut up?
As with all things in life, balance is probably the best approach. For some employees, taking out a loan against their 401k may be the only source of cash they have in an emergency. That's hard to argue with. Employees looking to finance the second waverunner may need a financial consultant.
Here's your checklist of talking points if you want to advise a member of your tribe of the downside of a 401k loan, provided by the 401khelpcenter:
- There are "opportunity" costs. According to the U.S. General Accounting Office, the interest rate paid on a plan loan is often less than the rate the plan funds would have otherwise earned.
- Smaller contributions. Because you now have a loan payment, you may be tempted to reduce the amount you are contributing to the plan and thus reduce your long-term retirement account balance.
- Loan defaults can be harmful to your financial health. If you quit working or change employers, the loan must be paid back right away. It's not uncommon for plans to require full repayment of a loan within 60 days of termination of employment. If you can't repay the loan, it is considered defaulted, and you will be taxed on the outstanding balance, including an early withdrawal penalty if you are not at least age 59 ½.
- There may be fees involved.
- Interest on the loan is not tax deductible, even if you borrow to purchase your primary home.
- You have no flexibility in changing the payment terms of your loan.
That's a pretty strong list, especially the one saying that if an employee leaves the company, they must payback the loan in the short term. If an employee is taking out a loan from the 401k in the first place, they probably don't have the means to do that, which likely means default.
So back to the loan that made me flinch from visions of Tony Soprano and Paulie.. Here are the specs of the loan from 2000, which was part of another plan, a long time ago, in a land far away (enough disclaimers?):
-Original Loan Amount - $8,600 and change...
-Interest Rate - 11.5% (ouch)
-Total Payments Needed to Retire Loan - 390 (15 years)
-Total $$ Needed to Retire Loan - $18,000 and change (Meaning over 9K in interest expense beyond the $8,600 principle)..
Again, some employees won't have access to any funds other than their 401k in emergencies. That's OK. But coach everyone who asks about the realities related to a 401k loan, especially if the loan must be paid back immediately after the employee leaves the company.