Question: Erick, we recently had a participant ask if they can repay their 401(k) loan early. Honestly, this has not come up before. What should we consider in making a decision? Because of the way loan repayments are applied in our system, we expect there would be difficulties just in terms of the technology?
Answer: This is a question in which you will need a legal opinion. However, there are a few key considerations to consider — and systems difficulties aren’t really at the top of the list. Similar to other questions about qualified plans, meeting the prudent person test should come first. Maybe the participant realizes the interest he or she is paying back to his or her account is less than the account could earn if invested. Failing to allow the loan to be repaid could give that participant a reason to look to the courts for redress. Another potential problem could arise if the participant is not allowed to repay the loan in its entirety and later defaults. That, too, could create a fiduciary breach. Remember, mere functional procedures (as opposed to those that are specified in the Plan Document, the Summary Plan Description, or other governing documents) are just not as important as is prudence in operating the plan. So if the prudent thing is to allow prepayment, then that’s what should happen in spite of any technology challenges. Here’s an interesting discussion on the topic, which appeared on BenefitsLink.
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For plan sponsor use only, not for use with participants or the general public. This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation.