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WASHINGTON-Employees don't necessarily have to sign on the dotted line to borrow from their 401(k) plans, the Internal Revenue Service says.
The recent IRS letter saying a participant's signature is not required for a 401(k) loan will not significantly alter plan administration but could eliminate some administrative burdens, consultants said.
The general information letter from the IRS to a lawyer representing Bankers Trust Co. of New York says employees need not sign loan documents to borrow money from their 401(k) plans, provided the loans are legally enforceable.
Bankers Trust, along with Hewitt Associates L.L.C. of Lincolnshire, Ill., and Fidelity Investments of Boston, requested the letter in their roles as plan administrators.
The letter will not eliminate paperwork for loans, said Michael Barry, managing director-plan advisory services for Bankers Trust. Plan participants, however, may no longer need to sign and return loan documents, and plan administrators may no longer need to keep signature cards on file.
"Most of our clients do not use signed loan documents anyway, and we will probably go back to our clients and see what documents can be eliminated," Mr. Barry said.
Overall, consultants say the impact won't be significant. "This is not some giant step forward," said Jim Klein, a principal with Towers Perrin in New York. He said many companies already have signature-free loans, but the letter might influence some previously hesitant companies to eliminate signatures.
"It will help the progress towards paperless transactions," said Tom Butterworth, a consultant with Hewitt Associates in New York. "But I wouldn't want to suggest it will be a dramatic sea change, because lawyers still want security on the issue of loan enforceability."
One large issue the letter does not address is whether a signature-free loan is enforceable. This is an unresolved legal question on which benefit attorneys give differing opinions, consultants said. Some attorneys take a conservative approach and say a signature is required for a loan, while others think no signature is required, that simply the endorsement on the back of the loan check or the depositing of the money makes the loan enforceable.
Enforceability of the loan is very important. If the loan is not enforceable, it might be considered a distribution and therefore subject to taxation and possible penalty. The approach taken by states on enforceability of electronic signatures varies, said Henry Saveth, a principal with William M. Mercer Inc.'s Washington Resource Group.
But for now, loan documents will continue to be be used. Bankers Trust sends these documents to plan participants along with the loan check. The loan documents state the amount of the loan, the terms of repayment and state that depositing the check means the participant agrees to all the terms.
"We still believe there is a piece of paper that is necessary at this point, and that is the loan agreement," Mr. Barry said. "This is an evolving process, and it's conceivable that in five years no paper will be required."
One advantage of the ruling may be the elimination of TAC cards, short for Transaction Authorization Cards. These cards are completed and signed by employees when they join 401(k) plans and are kept by the plan administrators to allow future transactions without additional signatures. The ruling may render the need for a signature on file obsolete and remove an administrative burden. "Elimination of TAC cards will be a major achievement," Mr. Barry said.
Elimination of TAC cards is only part of the goal of plan administrators. The ultimate goal is eliminating all paperwork and making the transaction completely paper-free so that participants can arrange for the loan over the phone or Internet, and receive the check a few days later. This system will not only reduce administrative work but will speed up transactions that drag on as paperwork is retrieved and sent between the participant and administrator. "That's a problem we really don't want to have," Mr. Barry said.
One concern with making loans too easy, consultants said, is that employees may too frequently withdraw money from their 401(k) plans.
Because the plans are intended for employees' retirements, loans reduce the money-if not repaid-later available to them. Because employees contribute their own money into the plan, however, consultants say without a loan feature, many employees won't participate at all.
"They (loans) may pose a risk to retirement fund plans," Mr. Saveth said. "But those funds might not be in the plan to begin with if there is no escape hatch in the plan in the form of a loan."
Eliminating paper might also reduce participants' awareness of the effects of the loan.
When someone takes out a loan from a 401(k) plan, he or she repays it, with interest, through payroll deductions. If the employee leaves the company before the loan is repaid, however, the outstanding balance of the loan is treated as a distribution and is subject to taxes and penalties.
Because of these issues, companies try to educate their employees about the risks of taking out a loan.
What they will not do, however, is oversee their employees' activities. Most companies have adopted an "I won't hold your hand but I will educate you" philosophy, said Marty Collins, a senior consultant with The Kwasha Lipton Group in Fort Lee, N.J.
Despite its limitations, the letter will help push 401(k) plans into a paperless environment, like many other financial transactions, consultants said. "Qualified plans will not be held back in the 20th century if the rest of the world advances into the 21st century," Mr. Saveth said.