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Plan Sponsor Guide: Understanding 401(k) Loans

Updated: Dec 14, 2018


The recent enactment of the Tax Cuts and Jobs Act of 2017 (TCJA) makes changes to 401(k) loan repayment options, which should prompt plan sponsors and plan administrators to re-evaluate their existing loan program, processes and procedures. This article will provide an overview of the loan provision and offer a list of considerations that plan sponsors can use when adding or modifying an existing loan feature to their plan.

Although not required by law, many 401(k) plans offer a loan provision as a way for plan participants to access money prior to retirement. The thinking is that more employees will contribute to the plan if they know they can tap into their savings should they incur an unexpected expense while working; conversely, if employees can only access their savings at retirement, employees may decide not to contribute at all.


Rates & Loan Amounts

The loan rate is determined by the plan (i.e., the plan sponsor or plan fiduciaries) and is usually equal to prime rate plus 1%. Plans will often set a minimum loan amount of $1,000 due to the administrative work involved in processing them. The maximum loan amount is usually 50% of the participant’s vested account balance up to $50,000.


Special considerations are available for participants affected by certain natural disasters and it’s a best practice to check the IRS’ website for more information.


While loan rates and minimum loan amounts are fairly consistent across all plans, there is less commonality on the number of permitted outstanding loans. Recent findings from the PLANSPONSOR 2017 DC Survey: Plan Benchmarking reveal that 59% of plans offering loans only offer one loan, 31% offer 2 loans, while 9% offering 3 or more outstanding loans.[1]


Offering plan participants the ability to have more than one outstanding loan may feel like a gratifying gesture on behalf of the employer. However, participants may view this as an endorsement by the plan sponsor to simply take a loan whenever money is needed.


The Pension Resource Council in 2014 revealed that participants who have access to multiple loans are more likely to borrow in the first place: “This is suggestive of a buffer-stock model also found among credit card borrowers. In other words, given the ability to borrow multiple times, workers are more willing to take the first loan, given that they retain slack borrowing capacity for future spending needs.”[2]