A loan at last?

• Author: Maloney, John A.
• Position: Loan feature of 401 k plans - Employee Benefits

Adding a loan feature to your 401 (k) can perk up participation in a hurry, but you need to know your way around ERISA and how to minimize the extra administrative costs.

In only five more years, some 3.5 million workers will participate in approximately 310,000 401 (k) plans with total assets of $1 trillion. To encourage employees to participate as much as possible, many companies adopt loan provisions, which allow participants to borrow part of their retirement money without incurring an early-withdrawal penalty. But it's estimated that only about 65 percent of all 401 (k) plans have loan provisions.

The reasons are simple. While loans help you attract more participants, they also add to your plan administrators' workloads and responsibilities and, ultimately, to your administration costs. What's more, they contain potential tax traps, and your administrators are also responsible for helping employees avoid those pitfalls. So if you're thinking of adding a loan provision, you should carefully review the responsibilities that your administrators or an outside firm would assume.

First, make sure you thoroughly understand the complex set of rules governing the administration and granting of 401 (k) loans. Loans are permitted only if the plan language specifically authorizes them, although you don't have to put in a loan provision when you first adopt a 401 (k) - you can add it later on. Sole proprietors, business partners with a greater than 10-percent share and S-corporation shareholders with a greater than 5-percent share generally aren't eligible for loans, unless you get a specific Department of Labor exemption. But the loan provision is open to all other participants.

Loans of more than $3,500 are subject to federal written spousal-consent rules. If a married 401 (k) participant applies for a loan, you must inform the spouse of the loan in writing, and the spouse must give his or her written consent within 30 days after receiving the notice.

You also need a formal loan policy that will identify the person or persons responsible for administering the loans, describe the loan-application procedure, set out the basis on which you'll approve or deny the loans, specify the amount and type of loans you'll permit, describe the process of determining interest rates, identify the collateral necessary to secure the loans and spell out default procedures.

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