When I draft a new 401(k) plan for a client, one of the first provisions I’ll recommend—including with some reluctance—is a loan feature. Not because I enjoy dealing with it. On the contrary, it’s an administrative pain. But because I believe, deeply and stubbornly, that participants should have access to their own money if they find themselves in a bind. Life doesn’t schedule emergencies around retirement planning. People don’t always have the luxury of waiting until age 59½ to solve a crisis.
That said, experience has taught me where to draw lines. A loan feature in a retirement plan without limits is like handing out aspirin in a hurricane—unhelpful, possibly dangerous, and guaranteed to create more work later. That’s why I always set a $1,000 minimum loan amount. I don’t want participants draining their accounts $250 at a time, especially not when each loan is subject to a $50–$75 fee. Borrowing small amounts ends up being self-defeating. Those fees are disproportionately high, and frankly, if someone’s emergency is a $250 problem, there might be better ways to help them than with a retirement loan.
I also insist on a one-loan-at-a-time rule. I’ve seen plan records—some managed by large providers, mind you—where participants were juggling eight or nine loans simultaneously. That’s not a retirement plan; that’s a shadow banking system, and it’s a compliance disaster waiting to happen. Every additional loan increases the chances that something goes wrong, and trust me, things do go wrong.
Even with those guardrails, loan provisions cause headaches. Payroll mistakes are common. One missed payment and suddenly you’ve got a prohibited transaction on your hands. If quarterly payments aren’t made, the loan defaults. That’s when the dreaded 1099-R gets issued to the participant. There’s no joy in handing someone a tax form that essentially says, “Congratulations, your loan is now a taxable distribution—and you might owe penalties, too.” Especially when that happened not because they failed to pay, but because someone in payroll missed a line in a spreadsheet.
The worst part? These loan errors usually don’t come to light right away. They hide in the weeds. You only find them during a government audit or—more likely—when the plan changes third-party administrators. Then it’s a forensic exercise. You’re piecing together loan histories from years ago, trying to reconstruct amortization schedules and payroll feeds from a different HR system. It’s a migraine, not just for the TPA or advisor, but for the plan sponsor who now has to correct a problem they didn’t even know existed.
So yes, I include a loan provision. Not because I like them, but because sometimes the human element of retirement planning matters more than pristine administrative simplicity. But like anything in this business, good intentions are useless without strong procedures. Want a loan provision in your plan? Fine. Just be prepared to babysit it like it’s your firstborn child.
