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Participant Loans in Defined Contribution Plans: Key Pros and Cons for Your Business

by Caldwell Trust

Participant Loans in Defined Contribution Plans Key Pros and Cons for Your BusinessThe decision to offer participant loans in defined contribution (DC) plans is complex and requires careful consideration.

As an employer, it is commendable to want to provide a range of financial options for your employees. However, you also want to make sure that the benefits to your organization—and to your employees—outweigh the costs of such a program.

Before signing off on providing participant loans in DC plans, there are a number of things for you to consider.

When and Why Do Employees Typically Consider Borrowing from Their Retirement Plan?

Whether your business offers a 401(k) or 403(b) retirement plan, it is important that you consider the timing and reasons that employees may take out a DC participant loan. It can help you understand their initial motivation, as well as their plans or ability to repay their loan based on the terms.

According to the Society for Human Resource Management, nearly one-third of employees have borrowed from their retirement plan. Many of those surveyed indicated that their loan was intended to pay off debt while other respondents noted that their loan was used for emergency purposes.

What’s more, a series of surveys conducted by the Investment Company Institute (ICI) to monitor plan participants’ loan activity found that the number of participants with outstanding loans fluctuates based on two main factors: financial stresses and a seasonal pattern (via PlanSponsor).

Also, keep in mind that there are times when employees may qualify for a hardship distribution. While any DC plan can offer loans, only 401(k), 403(b), and 457(b) plans can allow hardship distributions. In those cases, it is important to make that distinction and explore the most current hardship distribution rules.

Weigh the Pros and Cons of Offering Participant Loans in Defined Contribution Plans

As with any important decision, it can be helpful to look at the pros and cons of participant loans in DC plans.


  • Employees Can Attend to Personal Needs. Whether an employee needs to buy a car, help an aging parent or replace their home’s roof, offering participant loans can benefit your employees in their times of need.
  • Loan Access May Lead to a Higher Employee Contribution Rate. The National Tax-Deferred Savings Association reports findings that DC plans that allow participant loans experience a significantly higher employee contribution rate than for plans that do not allow loans.
  • Participant Loans May Spur Increased Employee Retirement Savings. Most participants - especially those who do not have access to home equity loans or other reasonable financial resources - may use their loan to consolidate debts, and in turn,  reduce the costs of borrowing. This gives them more financial freedom to increase their retirement savings.
  • Retirement Plan Leakage. When participants take out loans and don’t repay them, they deplete their employee-sponsored retirement plan. Having a “leaking” plan could mean that the employee may not be ready for retirement when the time comes, but it could also lead to higher record-keeping fees for employers.
  • Administrative Costs Run High. Plan sponsors invest significant time and expenses into initiating, processing and administering participant loans. This includes program communication, collection of loan repayments and tax-reporting requirements.
  • Employment Termination Brings Its Own Challenges. Any time that an employee is terminated, the loan is immediately closed, causing retirement assets to leave the system.

Do You Have Other Options Available to Financially Assist Your Employees?

If you prefer not to offer participant loans in your DC plan, there are other options you may consider.

  • Create an employee-sponsored emergency fund
  • Offer an employee stock purchase plan (ESPP)
  • Build a third-party partnership to offer employees low-cost loans
  • Offer discounts on financial planning assistance
  • Provide an employee financial wellness program

There are many factors to consider before offering participant loans in your retirement plan. Loans can be beneficial to employees during financial hardships, but they can also have serious implications for your business. If you need help with deciding whether to offer participant loans, partner with an experienced trustee, like the experts at Caldwell Trust Company, to help you find the best solution for both your employees and your business.


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