Time to Eliminate Loans in 401(k) Plans? Balancing Fiduciary Concerns, Retirement Outcomes & Employee Perceptions
Question: Some would argue that retirement plan loans are an employee benefit and curtailing them would hurt a company’s employees. How would you respond?
Bruce Ashton: I think there is some truth to that, though curtailing participant loans might hurt employers more than employees for a few reasons:
The common wisdom is that employees want to have a 401(k) plan because they understand the need to put money away for retirement. At the same time, they are concerned that emergencies may arise and they won’t have the money to pay for them. So they want to have access to their retirement “savings” to cover the emergencies. Given this mindset, employers want to provide a plan with a loan provision to satisfy the expectations of potential employees. Employers may have concerns that if they curtail loan availability, they won’t be able to attract and retain employees. I think that could be true.
Looked at from the employee perspective, I understand the concern about having access to “emergency savings”, so eliminating loans could hurt the employees, since their alternative might be to take a hardship distribution (if it’s available) or simply suffer. I don’t advocate suffering, and hardships are a worse alternative because at least a loan can be repaid, whereas a hardship distribution represents permanent leakage.
All of this being true, what’s an employer to do? I’d say keep the plan loan provision, make it as flexible as possible in terms of repayment after termination of employment, try to educate participants on using participant loans responsibly, but – and this is most important in my view – require loan insurance to at least plug the hole that’s caused by an unexpected, involuntary termination.
Bruce Ashton, Partner,
Bruce L. Ashton has more than 35 years of experience handling employee benefits matters. His practice concentrates on representing plan service providers (including RIAs, independent record-keepers, third-party administrators, broker-dealers and insurance companies) in fulfilling their obligations under ERISA. His experience includes representing public and private sector plans and their sponsors, negotiating the resolution of plan qualification issues under IRS remedial correction programs, advising and defending fiduciaries on their obligations and liabilities, and structuring qualified plans, non-qualified deferred compensation arrangements.
Combining his employee benefits and transactional experience, Bruce is also active in the installation and funding of employee stock ownership plans (ESOPs).
Bruce is a contributor to Drinker Biddle’s Broker-Dealer Law Blog, which provides practical insights on litigation, regulatory, compliance and fiduciary issues impacting broker-dealers. He has co-authored four books on employee benefits issues and a quarterly column in the Journal of Pension Benefits on IRS remedial programs, and is a frequent contributor to various tax and pension publications. He is a frequent speaker on employee benefits issues ranging from fiduciary responsibility to ESOPs, and is a regularly featured speaker at conferences sponsored by ASPPA, and other organizations.
Recap, Highlights, and Thoughts
Could retirement plan loans be the next big fiduciary concern for plan sponsors? Hard to tell, but my conversation today with Bruce Ashton, ERISA Attorney and Partner in the Employee Benefits and Executive Compensation Practice at Drinker Biddle, will certainly help you understand why multiple regulators are taking a harder look at the retirement plan loans, especially defaults. We cover a ton of ground including my opening question which is likely the first thing that would come to the minds of most employers, we delve into how loans become a fiduciary concern and much more. I also ask Bruce the inevitable question of whether the time has come to eliminate loans in workplace retirement plans.
Here is a link to Bruce's white paper we discussed during the episode.
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NEW: Episode Transcript
Rick Unser: 00:00 Well. Bruce, welcome to the podcast. I am really looking forward to our conversation today about 401k loans and defaults and fiduciary issues and all that fun stuff, so can't wait to hear what you have to say.
Bruce Ashton: 00:12 Well, it's my pleasure, right? Yeah. I've always wanted to be on a podcast.
Rick Unser: 00:16 I'm glad it could make that a, that dream possible. If you have any other ones, just just let me know. See what I can do.
Bruce Ashton: 00:21 I'll be sure to do that.
Rick Unser: 00:23 Well, Bruce, I guess just right out of the gate, let me get this straight here. An employee borrows their own money from their retirement account through a retirement plan loan, a 401k loan. In this day and age plan sponsors generally have very little involvement in approving those loans. The participant even signs their life away that they've got to pay it back or there's potential taxes and penalties, and I think what you're going to tell me during this episode is now we're going to tell employers that there's risk in that quote unquote transaction
Bruce Ashton: 00:56 Essentially. Yes, and let me expand on that briefly. I think the problem is that there's been a myth that participants are, are essentially taking money out of their own piggy bank. So why should the employer be concerned about that? The fact is that the money is not in a piggy bank. It's in a plan that is subject to ERISA. And so plan sponsors have certain responsibilities even for participant loans. And we can talk about those responsibilities in some more detail a bit later, but essentially there are responsibilities under ERISA, even for participant loans and you know, those really can't be ignored. That problem is with leakage and loans are a huge contributor to the leakage problem. But this is one of those leakage problems that can be ameliorated. Once plan sponsors pay attention to it.
Rick Unser: 01:58 And that's one of my favorite words, actually. Not really, but when, when you say leakage what is it that you mean by that and darn it, we could not have come up with a better word for that in the industry.
Bruce Ashton: 02:10 Well, it is an interesting word that's being used in this context, but basically the term is used to describe a situation where retirement savings are coming out of a plan, shall we say prematurely. That is before the participant reaches retirement age. So the funds are not available for the participants retirement. And the concept is that the funds leak out when a participant changes jobs very often. Or in this context where the participant defaults on the wound, especially at termination of employment.
Rick Unser: 02:48 Yeah, I'm with you and it's, it might not be the best word, but it does sort of the leaky bucket I guess analogy. Right. So to put this in perspective, as I look at just some general loan data, 13 to 20% of plan participants have alone. 40% of participants will take a loan over a five year period. Average loan balances are, you know, a little under $10,000. Does that kind of match with some of the numbers that you're seeing out there?
Bruce Ashton: 03:19 It does. And there's, there's some additional statistics that I think are relevant here and one of the reasons that I think we're starting to get additional focus on this issue, notwithstanding the fact that employers have always looked at this as well, we're just loaning the money to the participant. You know, it's his own money. So why should we be all that concerned? And the problem is presented in some of the additional statistics that I'm going to talk about and that is that there's about a 10% default rate every year on participant loans. Of that amount, 86% nearly 90% of the defaulted loans default on separation from employment. So when somebody leaves their job, they've got a participant loan outstanding in almost 90% of this, the cases they default on the loan, which causes it to be tax to them and taken out of their account of that 86% that default as a result of separation from employment over 90% of those result in an offset against the participant's account. So the fact that there's a lot of participants that have loans and there's a fairly significant default rate and those defaults result in a huge percentage of situations in which the money comes out of the participant's account and is no longer available for their retirement later on is a very startling statistic that I think is one of the reasons that this issue that we're talking about today is coming to the fore.
Rick Unser: 05:04 And let me just, I guess for the abundance of clarity, just asked you to, to, to give me an example there. So someone has a $20,000 balance, they've got a $5,000 loan, they terminate, they've had that $5,000 loan outstanding. They either don't have an option to pay it back, they can't write a check for $5,000 there's no other way that they can continue paying the loan after termination. So their balance goes from 20,000 with a $5,000 loan to now they have 15,000 am I thinking about that right? Or did I just oversimplify that too much?
Bruce Ashton: 05:47 Not at all. And, and you're absolutely right. If the outstanding balance on the loan at the time they terminate and then default on the loan is five grand, they're taxed on the five grand right then and the 5,000 reduces their account balance. In the example you gave from 20,000 to 15,000 so yeah, that's exactly what happens. And that has a compounding effect too, because that 5,000 is no longer available for earnings and over a period of time that $5,000 without earnings is a fairly startlingly large number for the participants and for the plans as a whole.
Rick Unser: 06:31 Yeah, and just if, if you look at, I don't know, I've tried to explain this to some people over the years, and I feel like if people just look at that rule of 72 and just say, hey, if you were to earn a 7% rate of return, your money's roughly going to double every 10 years. So someone who defaults on a loan of $5,000 if they're maybe in their mid or late twenties hypothetically, that could double four times by the time they get to retirement. So that you know, $5,000 hey, maybe that sounds like a lot of money or maybe it doesn't sound like a lot of money, but once you extrapolate that out, that can become a pretty significant sum that all of a sudden is, you know, removed from that compounding equation.
Bruce Ashton: 07:11 Exactly, exactly.
Rick Unser: 07:13 And you mentioned this a minute ago and you got me distracted by the leakage thing, so, so let me come back here. I apologize. I would really agree with you that I think if you were to talk to the average committee or even let's just say not your average committee, and it may be a very quote unquote sophisticated committee. I think you're absolutely right. The, the, the perception, the belief, the, let's even call it the understanding that a lot of people have when a participant takes alone is yeah, they're borrowing money from themselves. I mean, they are, I liked your piggy bank analogy. You know, they are basically just tapping their piggy bank and they're borrowing that money. They're paying themselves back interest and yeah, we can argue a little bit that they might've earned more if they kept their money in the market or whatever the case is.
Rick Unser: 08:00 Or maybe you're paying some double taxation on the rate of interest that you have on the account, but I think most people really view that as a transaction that someone is making with themselves versus something that is more of a plan level, a ERISA level type of either transaction or issue or whatever the case is. So can you maybe just just extrapolate on that a little bit in terms of what you mean by, you know, people aren't really borrowing into themselves, they're that, you know, this is a transaction with a plan governed by ERISA.
Bruce Ashton: 08:32 Sure. When you look at the, the guidance that's been out there for a very long time, it's clear that loans are part of the fiduciary obligation of the plan committee, the plan sponsor, and it's always been a fiduciary issue, unfortunately, just one that hasn't been widely recognized and it's a fiduciary issue for two reasons. We start with the proposition and the understanding that setting up a loan program is essentially a settlor decision that is the business owner makes a business decision in the design of therefore onk plan to permit participant loans. And there's some potentially very good reasons for doing that, which we can talk about later. But the decision to have the loan program is a business decision, what we call a set decision. That said, administering the loan program is a fiduciary obligation. So loans are part of the fiduciary obligation as a plan sponsor. The Plan Committee for that reason, assuming that the plan authorizes participant loans, there's a second way in which the fiduciary issues are implicated and that's when a participant cakes alone and the DOL has said in a number of different places and a number of different ways that loans, and this is gonna be a little startling to most people I think, but loans are essentially plan investments and sponsors have the same obligation to manage and monitor them that they do for any other plan investments.
Rick Unser: 10:18 As you were kind of describing that I was just scratching my head a little bit. I'm thinking about how I explain this to a committee or how I explain this to a plan sponsor who's like, hold on a second. You know, I've been told my fiduciary responsibilities are to review my funds, make sure I have reasonable plan fees and make decisions that are in the best interest of the plan participants. I mean there's obviously some other stuff that goes into that, but I think if you look at kind of what, what most plan sponsors believe they need to be doing with their retirement plan, I think that kind of sums up some of the basics, but maybe help me, you know, help me back into again how they need to add loans and or what they would need to do to make sure they're being good fiduciary is around, you know, monitoring their loan programs.
Bruce Ashton: 11:07 Sure. I mean I think we need to look back at a number of the statements that DOL has made about participant loans and basically they've said, yeah, it's fine to have a loan program, but keep in mind that the obligation of the fiduciaries is to act in the interest of the participants for the exclusive purpose of providing benefits and a loan is not per se a benefit. It's the retirement benefit that the DOL is talking about. So the loan program has to be administered in a way that doesn't interfere with the provision of the benefits to the participants. And that means looking at the loan program and what are the features of the program. Are there lots and of defaults? If there are defaults, what can we do about that? Are there educational opportunities that we can provide? Are there ways in which we can tend to minimize the existence of defaults?
Bruce Ashton: 12:05 One of the situate, as I described earlier in the statistics, one of the most significant events of default is termination of employment. And that is especially true when it's what I call an involuntary termination of employment. That is persons laid off, they become disabled potentially even they die. You know, those are all what I call involuntary termination of employment events. And those lead to loan defaults. Well let's take the easier situation, the one that is somewhat predictable and that is, you know, layoffs. If the employer knows that there's going to be a layoff in the near future. And one of the features of their loan program is that when somebody terminates employment, the loan becomes immediately due and payable. And essentially there's gotta be some recognition that the participant who's laid off isn't necessarily going to be able to pay off that loan. So should the, the employer then the approving participant loans or should they in effect say, you know, we've got an event coming up, we can't talk about it cause there's not a public matter yet, but we're not approving loans for the next 30 days so that participants are not in a position of taking a loan, then they're laid off and then they're immediately put in false situation.
Bruce Ashton: 13:34 So it's, it's that kind of what I call paying attention that I think plan sponsors need to start doing when it comes to participant loans.
Rick Unser: 13:45 Yeah, that, that's a, that's an interesting perspective I guess on that. And certainly one that I would imagine not a lot of people have heard or thought about in terms of one more step in the process to, hey, we're going to be divesting a business unit. We're going to be laying people off. We're going to, you know, shutting down a plant, whatever the case may be. So as you were describing it, the other thing that just kinda came to mind was some of this litigation that we've seen early on in 401k plans around stock drop suits, where I feel like a lot of what you just described there was kind of what some of the plaintiffs were saying about the stock drop cases where, hey, you know, the CFO, the CEO, the general counsel would sit on the 401k committee or the retirement plan committee and they knew the company was in dire straights, but they did nothing to take the company stock out of the 401k plan. And as participants we were harmed. I don't know. I mean maybe I'm conflating two things that are absolutely unrelated, but I feel some of the themes that you just mentioned there are a little similar. Yeah, no,
Bruce Ashton: 14:57 Yeah, I think it's a little similar, but I think there's some significant differences too. I mean it's one thing to say to a plan committee, you have to remove an investment and maybe as a significant part of the investments in the plan and you have to remove that investment in a way that doesn't harm the participants and if it's a publicly traded security and all of a sudden the plan starts dumping the stock on the stock prices [inaudible] you can imagine probably going to go down. So is that going to hurt the participants as much as not doing it? You know, you can argue that both ways, and I'm not going to argue that point both ways, but the distinction I'm trying to make is on the one the stock drop situation, there's an affirmative action that the plaintiff's attorneys are saying that plan committees have to take in the participant loan situation. What I'm suggesting a committee should be looking at is not taking an action that is to say not permitting a participant to borrow money from their account and to me there's a distinction there. Maybe it's not a valid distinction, but I certainly see it as a distinction between saying on the one hand you've got to dump the company stock. On the other hand, you've got to say to participants, we're putting a hold on participant loans for the time being.
Rick Unser: 16:28 No, I, I appreciate you kind of thinking and working through that one a little bit. Sure. I guess while we're on the subject, I've had several folks on talking about current and future litigation trends. I think a lot of people looking at the, you know, current 401k or Russell Litigation, a lot of that is focused on plan fees, inappropriate chair classes, things like that. In a future world or maybe even in the current world, does loan administration or loan issues, have you seen that creep into any current litigation or is that something that you think might become more prevalent potentially down the road?
Bruce Ashton: 17:09 Yeah, I, I haven't seen it come into any current litigation and I think there's not a number of reasons why we haven't seen this be a more prominent issue. It's partly because of that piggyback myth that I mentioned earlier. There hasn't been a lot of focus on loan leakage until fairly recently in the last couple of years and there's hasn't been any what I would consider adequate reporting to the regulators about what happens when loans go into default. And frankly, you know, the fiduciary that I'm mentioning are, you know, not exactly a no front page news most of the time. So I think it's a matter that people just haven't been aware of the obligation. That's point number one. Point number two though is to get back to your question, I can imagine that this could become an issue is raised in litigation in the future as the leakage statistics become more widely known and as the reporting of what happens to defaulted loans becomes more ingrained in, in the reporting process.
Bruce Ashton: 18:29 And I, I mentioned that because there had been some recent changes in how defaulted loans got reported. So the regulators are going to start seeing additional information about defaulted loans and it's going to be reported somewhat differently in the Form 5500 so I think there's certainly the potential for seeing this come up in litigation in the not too distant future because of that potential. I think this is an issue that plan sponsors, plan committees are going to need to really start to think about to educate themselves about the look at their loan programs and how they're being kind of managed and administered and Gee, what steps can we take? What steps should we be taking to try to immediately rate some of the leakage problem and therefore send off litigation in the future. And I think it's possible to do that. I just, I think now that we've seen the extent of a plan litigation over the last decade or decade and a half and it doesn't seem to be going away and in in fact seems to be going sort of down market, if you will, because smaller plans are now involved in litigation. I think plan committees need to pay attention to situations that could ripen into litigation and take steps to protect the participants and frankly themselves from that litigation.
Rick Unser: 20:01 Yeah, no, no. All good points. You mentioned something that I think is really important and I feel like this is always something that catches people's ears, which is new reporting requirements on the Form 5500 I feel like no matter what role on the committee somebody plays, whether they're the CFO, whether they're in HR, whether they're legal, it seems to be that any time they, you know, something new has to go on the 5500 everybody pays attention. So what is going on with loan reporting? You know, maybe currently on Form 5500 or any other kind of government reporting that needs to be produced and what is going to be happening or what's changing I guess in the, in the near future?
Bruce Ashton: 20:45 Sure. One of the really things about the Form 5500 reporting when you focus on it. From my perspective of looking at the loan issue, one of the interesting things is in the past when a participant terminates employment, the loan is offset against their account. The amount of the offset against the participant's account was treated as a distribution and reported as such and was lumped in with every other distribution that the plan makes. If somebody you know, retires, they get a distribution or if somebody dies, you know, their estate or their beneficiaries get a distribution and loan defaults that were offset were reported simply lumped in with that distribution statistics. So there wasn't possible to see, okay, how much of it was a distribution based on somebody who had a distributable of and and became entitled to a distribution and how much of it was a, an unfortunate situation of a offset against the participant's account where the participant didn't get the money distributed to them at the time they terminated employment and our tax on it, no opportunity to roll it over.
Bruce Ashton: 22:02 Although that may be changing under the 2017 tax law. But my point is that the information was just lumped in together so you couldn't distinguish between normal distributions and loan offset distributions. That is changing and on the Form 5500 it now will be reported with a separate code that says this amount of the distributable money, the money distributed to participants was a result of loan offsets. So that's one area where we're going to start being able to see the impact of the leakage problem. The other place it's going to come up is on the Form 1099R according to the potential event. And even though that's not a publicly available form, the regulators are certainly going to see it. And if the regulators see okay, a big portion of the distribution to the participant was as a result of a defaulted loan, you know, it strikes me that that could become an issue that the IRS and or the Department of Labor start to look at and say, okay, what's going on here? Why, why is that happening to the extent that it is happening. So there is this change in the reporting both at the participant level and at the plan level
Rick Unser: 23:23 And from a reporting standpoint, let, let me just focus on the 5500 for a second. Is that we're required reporting or is that optional or suggested reporting on that data you were just talking about?
Bruce Ashton: 23:39 No, that's going to be required.
Rick Unser: 23:41 Perfect. Yeah, I feel like there was something and maybe a year or two ago that was like, oh is kind of optional and I just recall a lot of record keepers and folks just saying, Hey, you know this is optional at this point so it's not quite required. And I couldn't remember if that was a loan thing or if that was something completely different. And what you just talked about with reporting DOL, they oversee the 5500 IRS. That's the 10 99 [inaudible] stuff. I feel like in either something you wrote recently or something I read recently, the GAO is also involved and, Yup. And I guess maybe what are they doing in, is all of this increased attention, really focused on the default issue and trying to get to the bottom of that? Or are there some other things that are that are garnering the attention of all these various agencies?
Bruce Ashton: 24:30 I guess I can't answer the second part of that. I'm not sure exactly why this is happening. I have my own suspicions as to why that's happening. But basically the, the DOL and the IRS have made these changes to the 10 99 hour and the form 5500 the GAO in a recent report talking about the leakage problem pointed out the significance of defaulted participant loans as one of the major elements of that leakage problem. And we made a recommendation again that there'd be more robust reporting of this on the Form 5500 so all of the agencies are trying to, number one, focus on the problem and number two, to get more transparency. And I think it's because regulators and particularly consumer groups are starting to really focus on the leakage problem. And I think part of the reason for that is we're starting to look at the fact that, well, okay, the 401k plan is a great device to terrific way for people to put away retirement savings, but when they get to retirement and their paycheck stops, their bills don't, and what do they do then?
Bruce Ashton: 25:53 How do they deal with being able to have retirement income? And if a whole chunk of their money is leaked out as a result of the participant loan problem, then it just exacerbates that problem of how to retirees actually retire with dignity and being able to afford to live going forward. To put this in perspective, Deloitte did a study in 2018 where they looked at the loan default issue and they came up with some really startling statistics. I mean, basically they said, take a fairly typical $7,000 loan balance and a roughly $70,000 account. And if the pretensive then defaults on that loan, let's say, because their employment is terminated over their expected working lifetime, let's assume a 42 year old potential Ben, they're going to lose about $300,000 in retirement savings. And part of the reason for that is again, for the participant who's has an involuntary termination, they're going to take their there.
Bruce Ashton: 27:10 Not only are they going to lose the money that is deemed distributed to them as the default alone, but they're probably also going to take a distribution of their account balance. So, but they got something to live on until they get a new job. So when you basically denude their account balance and look at, okay, over the next 20 plus years, what kind of earnings would they likely have received? Kind of the example you are using earlier, the loss is going to be about $300,000 so then Deloitte looked at, okay, what happened in 2018 and they estimated that there were, and this number just startles me, but there was seven point $3 billion in loan defaults in 2018 they then extrapolated that out over the next decade and projected that the loss in retirement savings over the next decade with this rate of loan defaults would be two point $5 trillion. That's true. Even with a t and that kind of number, staggering numbers seemed to be attracting some attention.
Rick Unser: 28:26 Yeah, no, those are, those are big numbers and certainly ones that will will grab your attention. And I guess let me ask you a somewhat provocative question, but one that I can imagine. Some people who are listening might be thinking, is it time to just do away with loans in workplace retirement plans?
Bruce Ashton: 28:48 No, I don't think so. I think that curtailing participant loans might hurt employers as well as employees. And let me expand on that just a little bit. I mean, I think the common wisdom is that employees want to have a 401k plan because they understand the need to put their money away for retirement. At the same time they are concerned about emergencies and will they have access to some of the money that they have saved. Whether that's a wise decision on their part or not, that is something that I think employees look to their 401k plan for. And given that mindset, I think employers want to provide a plan with alone provision to satisfy the expectations of potential employees so that they can attract them and retain employees. So the look that from the employer perspective, I think the concern is, gee, if we do away with loan programs entirely, unless everybody does away with loan programs, were not going to be able to attract and retain, you know, the employees that we want to get.
Bruce Ashton: 30:02 So that being the case, what's the employer to do? It seems to me that the employer would likely keep the loan provision, make it as flexible as possible in terms of repayment after termination of employment. Probably try to educate participants on using participant loans responsibly, but another thing they might do is consider loan insurance to at least plug the hole a little bit that's caused by unexpected involuntary terminations. And you know, we can talk about loan insurance in a bit more detail later, but it strikes me that the point I'm making is no, I wouldn't do away with loan programs entirely, but I would urge plan committees too as I keep saying pay attention and try to set up processes and procedures to help the participants who do take participant loans.
Rick Unser: 31:02 Let me just pull on a couple of those strings there. So again, assuming someone doesn't take that extreme and just eliminate loan programs from their 401k, which I agree with you, I don't necessarily see that happening, but if someone's kind of looking at their loan program and they just want to rip this thing apart and say, do we have the best processes in place to protect us? I guess one of the things I fall back on, and I feel like there's always a lot of attention paid to in the world of retirement plan administration is disclosures, notices, approvals, whatever the case is. If someone decides that they want to stay in the business of offering retirement plan loans, is having a good program around the disclosures of the fees and the risks and things like that that come with taking a retirement plan loan, is that enough to shield them or protect them from some liability?
Bruce Ashton: 31:59 I think the short answer is no. I think it's helpful to have a robust disclosure program, but I don't think it manages the risk or shields. The fiduciary is from exposure. Believe me, I'm all in favor of disclosure, but take a look at the plan investment litigation over the last decade or so and they basically, the issue that's come up in that litigation is that the participants have been given investment alternatives that were too expensive and very often the defense that's used is, well, wait a minute. We disclosed what the costs were and participants have to put their money, your most expensive alternatives and the response from the plaintiffs bar. And in some cases the courts has been, yeah, but that was all that was available to them. It's your responsibility to plan fiduciaries to select and monitor the investment alternatives and simply disclosing that they're expensive isn't enough.
Bruce Ashton: 33:04 You've got to make sure that the costs are reasonable. And it strikes me that the same kind of analogy might be made in the loan context. That is to say simply telling a participant that she'll be in big trouble if she's fired and her loan goes into default isn't enough. Because if the participant really needs a loan, they're going to take a loan, not withstanding all the disclosure that's being made to them. My point is that I think that additional steps need to be taken to protect the participants and also to protect the fiduciary fees and disclosure simply isn't sufficient. Disclosure by itself isn't sufficient.
Rick Unser: 33:50 No. I, I appreciate you sharing your thoughts there. And one other question that we get from committees is, okay, well I don't know if they're looking at their data and it's like, well, hey, we seem to have a lot of loans or we're concerned about having too many loans in our population. Can we put restrictions on those? Whether it be can we make some arbitrary guidelines for who can or who can't get alone? Or you know, could we apply the rules for hardships to the reasons that people could get loans? Is that another thing that you're seeing groups consider? And do you have any thoughts on, you know, best practices, I guess in terms of what people could or couldn't do or should or shouldn't do around putting any restrictions on loans other than just the basics that I think the IRS lays out of, you know, 50% of your account balance, no more than $50,000 et cetera.
Bruce Ashton: 34:45 Right. I think putting some restrictions, I am seeing that among my clients that have loan programs limiting it to one loan at a time and or no more than a certain amount of the account balance less than the $50,000 limit and the other limits and 50% limit that the IRS imposes. So I am starting to see restrictions and I think and in some cases the hardship concept that you mentioned earlier and I think that could be helpful, but at the same time I think plan sponsors and the fiduciary is need to look at among other things, education. Okay, what does it mean to take alone? What are the implications of it? Why should you take a loan? Why should you not take a loan? How should you manage your finances in such a way to help you through situations where you kind of need some extra money?
Bruce Ashton: 35:43 For example. I think one of the things that I'm seeing lots and lots of clients do and lots and lots of record keepers offer are financial wellness programs. And I think properly manage those can be very beneficial to explain to participants how should you go about managing your money so that they understand among other things the implications of the participant loan. So I guess what I'm saying is yes, I think restrictions could be very useful, very helpful, but I don't think by themselves it's sufficient and there should be education and perhaps other steps in addition to that.
Rick Unser: 36:25 Alright. So let me dig in with you on that. Cause you know we talked about disclosures and you mentioned that that's probably not enough. We talked about restrictions and that's probably not enough. So I like what you just said there about education. What are a couple of other things that in your mind would go into a well-managed loan program by an employer?
Bruce Ashton: 36:44 Well, yeah, I think the fact that you know, there, there are involuntary termination of employment and very often the, the loan comes due under the terms of the loan program. Immediately a found termination of employment. And I know that there are plans sponsors that are eliminating that feature of the loan program to say, well you can continue to pay the loan even though you're no longer an employee as long as you're a participant in the plan, you can continue to make payments on the loan. And I think that is or can be a good feature that plan sponsors ought to consider very seriously for those participants who change jobs who don't have an involuntary termination of employment. And I think that in that situation, if you set up the procedures in such a way that the participant, even though they've got a new job, they can continue to make payments on the old participant loan, that would be very helpful.
Bruce Ashton: 37:47 But also I think, you know, for, for plan sponsors to permit the rollover rolling out of a participant loan to a new plan or, and that the new employers permit the loan to be rolled into their plan a would be very, very helpful to participants. So that deals it seems to me with or can deal with the situation of a voluntary change of job. The issue that you know, I think still needs to be addressed and potentially is the bigger, more serious issue is the involuntary termination and that frankly, the only approach that I've seen that I think really works that I'm aware of is the loan insurance that I've mentioned earlier.
Rick Unser: 38:38 Yeah, and I think a couple of things you just mentioned there. I'd love to just at least get you to dig in a on the just one step below the surface on for me, the allowing loans to be repaid after termination. I think some sponsors over the years have kind of considered that, and I'm going to say my perception is have had a gut reaction that this adds risk to the plan. It adds complexity or compliance exposure to the plan. Do you agree with that? Have you heard that? Am I on an island thinking that or what would you say to some people that are like, Bruce, I get it. I hear what you're saying, but somehow some way I feel like we're taking more risk if we allow terminated participants to continue to repay loans.
Bruce Ashton: 39:27 I don't understand that argument that there's no risk. I can see the argument that there is a bit more administrative effort that's needed because you've got to set it up in such a way that you're no longer automatically taking the money out of payroll, but in fact you're setting up a procedure where the participant can ACH the money or however it's done. So yes, there is some administrative complexity, but I don't see any material added risk there. I mean when you think about it, and most people probably don't think about it this way, somebody who has an account balance and the plan is a participant in that plan regardless of whether they're an employee of a sponsoring employer and as a participant, the fiduciaries owe that participant non-employee participant the same obligations that they owe to the employed participant. So I don't see any added risk other than potentially, I suppose making sure that the service providers that are engaged to provide the ongoing loan payment arrangement are competent, know what they're doing and do it properly. So yes, administrative effort goes into it, but I don't see any any added risk.
Rick Unser: 40:52 I appreciate that. And then I guess kind of same question, same concept on loan rollovers. I know there are a lot of recordkeepers, a lot of plan sponsors that, you know, you talk about doing a loan rollover and I mean that is taboo. That is, you know, hold on a second, you know. No, how, no way, I mean, maybe we do this in a corporate divestiture or maybe we do this as a, you know, big block process. But I think the idea of an individual participant wanting to do an individual rollover out of one plan into another for their loan balance, I think then start getting people's heads starting to spin around on their shoulders and, and really starting to, to put up a lot of roadblocks around that. Again, that's my perception. Are you seeing some attitudes change or what would you want to communicate to folks that maybe aren't as accepting of that concept either at the sponsor level or the the record keeping administration level?
Bruce Ashton: 41:54 To answer your part of your question, no, I had lots seen a big uptake on, on this concept and I think it's because there's a kind of a gut reaction, well wait a minute, why should we take on the responsibility of having to administer this, the Sloan, when the participant comes into our plan, we didn't make Cologne in the first place, so why should we have the burden of having to administer that loan? And I understand that point of view more in those few situations where I've seen where the, the new employer doesn't permit participant loans at all. And frankly I have a couple of clients where that is the case. I won't go into whether it's working well for them or not, but for a plan that already has a loan program and it strikes me that yes, there are some administrative details that need to be dealt with.
Bruce Ashton: 42:51 Yes, they have to deal with the record keeper to make sure that they're able to administer that program. Yes, they have to deal with their payroll service to set it up properly to make sure that it happens. But if the plan already permits participant loans, the payroll service presumably doesn't care whether it's a rolled over loan that's coming in or whether it's a new loan that was made by the plan, you know from, from a payroll withholding perspective, that's six of one half a dozen or the other to the payroll service. It should be, it seems to me similar for the record keeper. I mean I don't mean to diminish or minimize the administrative details that need to be taken into account to make sure this happens properly. But the role over alone, it seems to me could be viewed as simply a new participant loan.
Bruce Ashton: 43:49 And the bigger issue I think is the fact that plan documents don't permit this at, at this point. Many don't even permit a loan to be rolled out of a plan that a participant is leaving and they certainly don't allow it on coming in by a new participant who's coming in from an existing account balance in an existing loan. So yeah, there's going to be some administrative effort that needs to be made to amend the plan documents on bond both ends and obviously if both aren't amended that can't happen. But I, yeah, I see that there's administrative that need to be taken care of, but I dunno, I guess my reaction, and maybe it's a simplistic one, is I just don't see it as something that should make people throw up their hands and run around in circles screaming.
Rick Unser: 44:46 Alright. I think I've actually seen that reaction once or twice, but,
Bruce Ashton: 44:51 Okay.
Rick Unser: 44:51 I think in all seriousness, the idea of individual loan rollovers, I think on the surface again, can make a lot of sense. But in terms of winning the hearts and minds, first of I think record-keepers and administrators that are actually having to keep track of all the details of that and, and having the systems in place to, to monitor and accept those or process those incoming outgoing loan rollovers on an individual basis. And then as you said, you know, you're going to have to win the hearts and minds of employers too. I think some are a little more willing to allow it on the outgoing side, but, but I do know there are, there's still a lot of trepidation to allow it on the incoming side. So I think maybe this is just kind of the beginning of the conversations that are just kind of socializing some of this that needs to take place for some of this stuff to gain a little bit more traction.
Rick Unser: 45:48 And as you know, I think people have to hear it multiple times before it really starts to set in or they start really thinking about things seriously. All right. And I guess just as a comment on the aside, I think Bruce, this is just a very, very timely concept because as we talk about 401k loans and retirement plan loans, and there's the problem on the involuntary side as we sit here towards, you know, August of 2019, we still have a very strong economy. We still have very low unemployment. We're not seeing a lot of massive layoffs. We're not seeing a lot of just downsizing, et cetera. That and the impact that that has on people's not only income and livelihood, but you know, also on retirement balances and loans. You know, we're not seeing that as, as we sit here today, but there does seem to be some signs on the horizon that we're potentially headed towards a recession. And, you know, usually as you start thinking about that universe sessions do come with some of the things that we've talked about and maybe a higher prevalence of some of these involuntary layoffs as we've talked about. So I, I think so much of what you said is so timely that you make hay while the sun shining for people to kind of take stock of situation, their situation today when maybe this isn't an issue. So that if and when it does become more prevalent in the future, you've got the processes in place.
Bruce Ashton: 47:20 Yeah, I couldn't agree more. I mean I couldn't have said it better myself.
Rick Unser: 47:25 Okay.
Bruce Ashton: 47:25 Because you know, anytime there's a financial and you know, who knows whether we're going to get one of those anytime soon or not, but that clearly is going to erode investment savings and it could increase the likelihood of participants taking loans, which increases the risk of defaults and seriously, which simply adds to the problem that the market downturn causes. So yeah, I think the way you put it, of looking at it while the sun is shining is, is a cogent point.
Rick Unser: 47:57 I appreciate that. And certainly didn't mean to steal your thunder there.
Bruce Ashton: 48:00 No, not at all.
Rick Unser: 48:01 Well, Bruce, you've mentioned a couple times this concept of loan insurance, and I'm going to go out on a limb and say, I don't think a lot of plan sponsors have heard of that. I know it's a newer concept for me. What did you mean when you said loan insurance might be an option for employers to consider to help with the challenge of defaulted loans with, you know, involuntary or maybe even voluntary separations and how, I guess, how does that come into play and what does that mean, et cetera.
Bruce Ashton: 48:35 Sure. To me, the concept of loan insurance, and I'll talk about what that means in a minute, but it strikes me that it is a more serious concern and potential solution in the involuntary termination situation. I mean, if somebody decides to change jobs, you know, that's, that's their decision. If they decide to leave their employment for other reasons, you know, for some other reason, that's their decision. But where they die, that's presumably not their decision if they're to become disabled, if they're laid off, those are, some people refer to them as catastrophic events. And it strikes me that an arrangement to protect the participants in that situation where the loan becomes due and they just cannot have paid for it is one that should be looked at and basically the loan insurance is one where the plan sponsor in setting up the loan program not only sets the terms of the loans but also says if you're going to take a loan participant you have to pay a relatively modest premium or insurance of that loan and the program that I'm aware of that provides this insurance, the policy is issued to the plan sponsor, so it is not a plan asset.
Bruce Ashton: 50:00 All of the plan itself is the insured under the policy and what happens is if a participant is involuntarily terminated from employment and is not able to pay their loan, the loan is in effect a defaulted loan. During the cure period. The insurance verifies the information and then pays the remaining outstanding balance of that loan to the plan as the insured under the policy. And then the plan agrees to take the money, it receives the insurance proceeds that receives and put those proceeds back into the account of the participant. And this all happens before the end of the cure period. So before the alone becomes a deem distribution and therefore the account balances restored, the participant doesn't have a dean distribution. And hopefully this will significantly reduce the incidents of loan leakage in the context of involuntary terminations. And the reason I say it's the only remedy, the only effective remedy that I'm aware of in the involuntary termination situation is because it's guaranteed to prevent taxation of the unpaid balance.
Bruce Ashton: 51:27 And because it restores the amount to the participant's retirement savings, it's automatic. It's relatively inexpensive compared to the benefit the participants receives. And to me, the, the concept that we talked about earlier of plans, allowing participants to continue to pay the loan after termination of employment is a fine idea for people that voluntarily terminate employment. But for the in voluntarily terminated, you know, they're, they're losing their paycheck, their choice is going to be between, well, gee, should I keep paying my loan balance to the back to the plan or should I buy groceries for the kids? And you can bet where that decision's going to come out. So if you have the loan insurance, the you take one of those issues off the table the participant who's involuntarily terminated doesn't have to make that decision between groceries and paying off the loan because the loan is paid off.
Bruce Ashton: 52:36 So I think that can be a very effective way of dealing with own problem. I must hesitate to add two things. One, I represent a firm that provides loan insurance. And in the interest of full disclosure, I wanted to say that, but in looking at the whole concept over the last number of years, and especially digging into the fiduciary issues, you know, I've become convinced that it's a worthwhile program. And let me add one other thing. I'm not giving legal advice, I'm not giving investment advice and I'm not giving fiduciary advice. So with those disclaimers, if people are interested in getting more information, they can go to www. Loan eraser. That's one word.com.
Rick Unser: 53:29 Perfect. No, and I would imagine just like with anything, the devil's in the details on that and I'm sure that can be a whole nother podcast episode. Kind of digging into digging, digging into some of that, you know Bruce, as we move to a close here, is there anything we haven't talked about relating to 401k loans or our workplace retirement plan loans more broadly that we should before we wrap up?
Bruce Ashton: 53:53 I don't think so. What I would reiterate though is for people to start paying attention to this issue, partly because it's coming up on the regulator's radar potentially because of the publicity around loan leakage, it's going to become more widely known among consumer groups and potentially the litigation bar and as you put it earlier, I think now is the time. All of a sudden their shining to look at the issue, to examine the loan program, to examine how it's being administered, to recognize that there are fiduciary issues and start paying attention
Rick Unser: 54:39 Now. And I couldn't agree with you more. I guess one last question. I really do think that, you know, we kind of flipped over a rock today that a lot of people probably haven't turned over in their retirement plan. So again I really appreciate you going through the level of detail that you did. Are there any other, you know, rocks are the proverbial couch cushion that people should be kind of turning over at this point that maybe is not getting a lot of attention out there but you think just bears mentioning
Bruce Ashton: 55:09 And again my theme here is paying attention and I think in the context of paying attention, it's important as again as you pointed out earlier to look at what's going on in litigation. Recognize that it's coming down stream if you will, down market and pay attention to what, what's happening in the lawsuits and pay attention to how people are, you know, winning those lawsuits. Pay attention to the settlements in those lawsuits and what is being demanded both in, not, not just in the monetary context, but in the administrative context of plans. And to the extent plan committees are not already engaging in certain monitoring activities to start doing so and taking the job as seriously as the plaintiff's bar is suggesting they should take it. And I don't mean that as grazing the plaintiff's bar, but I, what I'm trying to get across is that I think there are issues that plan sponsors really do need to look out and you know, if they need it, get expert advice because I don't think the litigation is going to go away anytime soon. Yeah.
Rick Unser: 56:32 I would give it through there. Well, Bruce, this has been extremely informative for me and hopefully for our audience as well. I really appreciate all the time you took and certainly now that we have exposed you to the world of podcasts, hopefully we'll have back again sometime down the road.
Bruce Ashton: 56:49 It would be my pleasure.