Similar to many of our business clients, we at Berman Fink Van Horn P.C. (BFV) are often faced with important decisions that can impact the well-being of our employees. For a change in pace, this article does not address legal matters. Rather, I hope that you will find my perspective and lessons learned from our recent exercise to be of interest to you and your business operations.
I am the Trustee of the Berman Fink Van Horn P.C. Profit Sharing and 401(k) Plan (Plan). We recently moved our Plan to a new company. As a result, I had the opportunity to fully scrutinize our Plan for the first time in many years. It was an arduous undertaking, even for someone who spends a significant amount of time dealing with legal documents. Many decisions had to be made. One of the most difficult decisions involved whether the Plan should include a Participant Loan Program (Program). After a thorough review of the pros and cons of including the Program and its possible effect on our employees, we opted to include the Program.
Central to our decision was our underlying appreciation that all of us at one time or another may find ourselves in temporary financial hardship where expenses, such as a large medical bill, making a down payment on a home, property taxes, college expenses, etc., may arise and bring about the need to borrow money quickly. Under such circumstances, some employees may have access to available credit on a credit card, or even family members who are able to provide assistance. Others may not. We concluded that BFV employees, especially those unable to gain access to funds when they are most needed, should have the right to a 401(k) loan.
Pros of Borrowing from 401(k) Plans. The most distinct advantage of a 401(k)loan is that it is a quick and easy process. There is no application to fill out, credit check, visit to the bank, etc. Interest rates can be much lower than an employee would expect to receive on most personal loan products and the interest paid is increasing the amount in the employee’s 401(k). 401(k) loan repayments can be deducted directly from payroll.
Cons of Borrowing from 401(k) Plans. There are a number of disadvantages associated with obtaining a 401(k) loan. First, once an employee withdraws money, the employee no longer has the tax shelter protection. Second, the interest that an employee pays on the 401(k) loan is paid with after-tax dollars and is taxable when withdrawn. In addition, studies show that the interest paid on a 401(k) loan is less than what would have been earned had no 401(k) loan been taken out. Finally, if an employee quits or loses his or her job, the 401(k) loan must be repaid in full within 60 days. If the 401(k) loan is not repaid within 60 days, the employee will be charged a 10% penalty if the employee is under the age of 59 and ½. The employee will also have to pay local, state and federal taxes as the 401(k) loan will be considered a premature 401(k) withdrawal and not a loan.
Notwithstanding all of the cons associated with a 401(k) loans, we believe that BFV employees should be able to make their own decisions. As such, our role is to at least give them the opportunity to access 401(k) loans. Ultimately, we concluded that since an employee’s 401(k) is fully vested, the money is the employee’s anyway.