Congress proposes to limit 401(k) leakage

The Rosenbaum Law Firm, Garden City, NY

A few months back, I wrote an article about some 401(k) provisions are bad ideas and quite a few of them were about some loan and hardship features that were burdensome to plan sponsors and could cause many errors in plan administration which puts the plan at risk for being out of compliance.

While I understand the needs for loans and hardship distributions (especially in today’s environment), I think having unlimited amount of loans or having loan repayments besides by payroll could lead to plan errors.

There was legislation proposed last month in the United States Senate called The Savings Enhancement by Alleviating Leakage in 401(k) Savings Act of 2011, or SEAL Act. The legislation gives some relief to participants and former plan participants with hardships and outstanding loans, but tries to minimize leakage of assets because of them. Even better, the legislation does not put any additional administrative burden on plan sponsors.

Some of the legislation’s features:

The bill would allow participants more time to repay loans if they lose their job. Currently repayment must occur within 60 or 90 days, or termination of employment, depending on the plan. The new law would extend that repayment period until tax filing deadline — April 15 of the next year. Workers would deposit the money into a qualified individual retirement account, so it would decrease the amount of defaults and not force 401(k) plan sponsors to do anything

The bill would allow a plan participant taking a hardship withdrawal to continue making contributions. Currently, a participant taking a hardship distribution cannot continue to contribute 401(k) deferrals for at least six months.  I understood the reasoning behind the six month kick-out used to be 12 months prior to 2002) because hardship distributions are as a result of a heavy financial need and how is it immediate if you can afford to defer immediately after getting a distribution? However, if the participants can resolve the financial emergency more quickly, this six month suspension only prevents the account from growing as a result of the participant’s contribution and the employer match. With a retirement crisis in this country, we want participants to save more for retirement and this provision will help do that.

The bill restricts the number of loans a participant can have outstanding at one time to three. More outstanding loans will increase leakage and help cause administrative errors. Limiting loans is a great idea and I suggested that in my article.

The bill bans the use of debit cards tied to a 401(k) account. It’s hard to believe, but some 401(k0 plans have allowed participants to tap into funds by using a debit card. 401(k) plans don’t need the financial equivalent of a payday loan.

Most congressional legislation stinks, the SEAL Act does not. It helps participants and former plan participants avoid leakage to their 401(k) plans. Even better, it does so without putting added burden to plan sponsors and their third party administration firms.