Convincing employees not to take out that 401(k) loan not only benefits those staffers’ financial health, it also helps keep you out of the feds’ crosshairs.  

In fact, the greater the number of 401(k) loans and loan defaults a plan has, the greater the chances that plan will be audited by the IRS and DOL, according to a presentation at the 2016 PLANSPONSOR National Conference.

The audit risk is particularly high with loan defaults.

Small fees, loan limits

To prevent loan activity that may set off some red flags with the feds, there are several things employers can do. For starters, firms can take some preemptive steps to prevent loans by implementing a small fee in the $50-$75 range.

Another option: Instituting a limit where the plan specifically states that employees can’t take more than one (or at the most two) loans against their 401(k).

But there are more drastic steps employers can take as well.

Insured against defaults

Employers can prevent 401(k) defaults and plan leakage by purchasing loan protection insurance.

This type of insurance pays off the retirement loan in one lump-sum to prevent a default and covers any outstanding balance as well as accrued interest.

One example: Custodia’s Retirement Loan Eraser (RLE). The RLE gives employers the option of:

  • making the insurance available to employees so they can protect themselves, or
  • purchasing the insurance themselves as a plan expense to cover all employees.

The program also offers a communication component where borrowers learn exactly how much they can lose out on in the long run by taking out a loan in the first place.

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