When writing a new 401(k) plan for a client, I recommend a loan provision even though it can be an administrative headache. The reason I’m adding it is because I think attendees should have access to money if it’s in their account if they need it.
However, there are some things I have put in place to eliminate some headaches. I always require a minimum of $1,000 for loans, there is no reason for a participant to take out a loan of $250, especially when the loan fee charged to their account will be $50 or $75 . Generally, you want it for people who need money, and de minimis aren’t going to meet that need.
I also like to have one loan outstanding at a time. I’ve seen plans where participants have 8-9 outstanding loans and it can be an administrative headache to ensure all are paid on time.
Even with these provisions, they often become a headache, especially when payroll errors make it impossible to repay a loan and you may have a prohibited transaction on the books if quarterly payments have not been made on the ready. There’s nothing worse than handing a 1099 to a participant because you failed to make sure the payroll paid off their outstanding loan.
They are also a headache in the sense that most loan errors are only discovered during a government audit or when there is a change of third-party administrator. This means errors are discovered years after they occur, creating a migraine or headache if you are the plan sponsor who needs to fix it.
So, even if you want loans in your plan, be careful how it works.
