Employee loans: What you need to know

Nicholas Mushayi / Posted On: 3 July 2022 / Updated On: 27 November 2022 / Compensation and Benefits / 291

Search Blog Click here to search the site.
Employee loans: What you need to know



Employees remain loyal to employers who recognize and satisfy their requirements, financial security, and motivations for professional progress and job happiness.

 

What will your employee do if a bad life event wrecks their finances and their current pay barely (or not at all) covers the cost? When something like this occurs, workers frequently leave their jobs in search of higher-paying positions elsewhere or incur more debt to make up the gap.

 

However, an alternative that benefits your business and its employees are employee loans. You can offer to loan them the money they require at a substantially reduced interest instead of finding a higher-paying position elsewhere.

 

Employees can increase their money and make investments in the future when you provide them with small loans. Because you are actively involved in meeting their financial needs, it is an opportunity to establish a long-term connection between your employee and your business.

 

So how does the procedure for lending money to a worker look? How can you manage all the legal nuances? You may learn more about employee loans in this article, including how they operate and what you can do to ensure everyone gets helped.

 

Quick fact: Employee loans are becoming increasingly popular in the United States, according to a new study. According to the American Management        Society, 78 percent of American workers now live pay cheque-to-pay cheque. Just 17 percent of people can ask a family member or friend for financial support.

 

What are Employee Loans

Employee loans are small sums of money the employer provides to the employee for a brief period. It could appear dangerous to lend to employees at first glance. However, when done right, it can be a useful strategy for lowering labour costs by keeping good workers.

 

They can meet their financial needs with the aid of loans without accruing any personal debt. Employers might provide loan money for various reasons, including unexpected medical expenses, school costs, housing costs, and more.

 

Employee loans frequently have an interest rate and payback plan, just like personal and commercial loans. However, the expense of operating the loan program and any tax responsibilities the company may have are typically covered by the low-interest rates on employee loans.

 

By deducting money from upcoming paychecks, the employee repays the loan in line with the repayment schedule. Employee loans might be seen as an advance on the employee's potential future profits.


There are two types of employee loans, which are: 

 

  • Money lent to an employee by their employer is the earliest kind of employee loan. The employer decides the loan's terms and conditions, which can differ substantially. But these sums typically have an interest rate, just like a conventional loan. Additionally, they want set repayment periods.

 

  • The second kind is money lent to an employee by a third party through the employer's benefits. Salaryfinance.com and TrueConnect are two examples of businesses that offer these loans.

 

The Pros of Employee Loans

1.    Financial Security

The cash flow can be improved by regular repayments of employee loans plus additional interest. Employee loans offer additional financial security for workers by acting as low-risk resources that can support them during difficult economic times.

 

2.    Attracting Employees

Prospective employees may view the availability of employee loans as a significant job bonus, making them a potentially effective recruiting tool. Just mentioning it shows potential hires that you care about your staff.

 

3.    Improving Productivity

Financial stress may have a detrimental effect on employee productivity, according to a growing body of research. This makes intuitive sense because spending more time worrying about money leads to poorer mental health, which lowers productivity. This financial aid might lessen the strain on employees under the correct circumstances.

 

4.    Alleviating Financial Stress

Employee loans help reduce the stress caused by money problems that cause your team to be less productive. In a study by the International Foundation of Employee Benefit Plans, 60% of respondents who experience financial stress stated their unease prevented them from concentrating at work, and 34% said it caused them to be more absentminded and tardy.

 

Focusing on work might be challenging if an employee worries about mounting medical expenses for family members, past-due rent, or other financial issues. Lending money to a worker to help them overcome these challenges might enhance their concentration and productivity at work. Employees might be inspired to work harder if they know that the company loaned them the money.

 

5.   An Affordable &  Low-risk Financing Option

Employee loans are a cost-effective and readily available choice for employees because they typically have lower interest rates than other types of lending and don't call for a credit check.

 

6.    Fostering Employee Loyalty

Employees who have gotten aid from their employer may be more inclined to remain with the company. Employees may feel more loyal to an employer if they know that they received assistance at a time of need and that the company had faith in them to pay back the loan. Retention and job satisfaction may benefit from this.

 

The Cons of Employee Loans

1.    The possibility of a default by the employee borrower

If an employee borrows money from their company and loses their job or suffers another financial setback, they may not be able to return the loan. Include loan loss clauses and default terms in the contract to prevent this.

 

2.    Administration Takes A Long Time

It's crucial to properly structure an employee loan if you decide to offer one. You expose yourself to tax and other liabilities if you don't.

 

Offering employee funding entails undertaking another administrative responsibility because it must be thoroughly documented. Of course, this duty may be lessened but not entirely avoided if you use employee loans from a third party.

 

3.    Significant Opportunity Cost

You invest time and money into something that might or might not pay you back when you make an employee loan. You also must divert time and resources away from activities that could help your small business expand. Therefore, employer opportunity costs associated with employee borrowing are substantial.

 

4.    Conflict among employees is possible

Employee disputes may result from a feeling of unfairness between those who have received loans and those who have not. Create an employee lending program with rules and be consistent to help mitigate this.

 

5.    The potential for disruption by office politics

Employees may attempt to exploit these loans as a kind of favouritism, which could cause friction between them and management. Before making any decisions, the employer should consider the possible repercussions of allowing employees to obtain loans.

 

6.    Repayment May Become a Source of Stress

Every circumstance is unique, but granting a loan to an employee who requests it to pay for regular and ongoing commitments like rent and utilities may be more detrimental than beneficial. Adding a new monthly cost on top of other duties might be stressful for an employee who already struggles to meet obligations. In this situation, suggesting financial advice could be preferable to making a loan that won't likely be repaid.

 

7.    Employer Tax Obligations may Rise Due to Lending

If the loan is not handled appropriately, it could result in employers owing more in taxes. The terms of loans must be transparent, and the interest rate must generally be applied at the applicable federal rate and reported as income. You could incur fines, tax requirements, or even legal trouble if the loan is not handled correctly. If the loan is not reported accurately, you could potentially face charges of breaking the law.

 

How Employee Loans Work

To prevent tax penalties and guarantee repayment, a loan agreement must be created. Follow these five steps to establish an employee loan program:

 

  1. Determine the amount of money to offer based on the employee's need and capacity for payback after conducting an interview (their debt-to-income ratio). Alternately, you might pay each employee the same set sum.
  2. To fully assess the circumstances (such as the most your firm can afford to loan and how frequently), speak with your accountant and a business lawyer, and then prepare the necessary agreement form.
  3. Decide who will sign the papers and oversee payroll deductions as your employee loan program administrator.
  4. Financial software can set up automatic salary deductions, record pertinent information, and create a loan-repayment account for the employee.
  5. Sign the documents and, if necessary, have a notary signing agent present.

 

Important Things To Consider On Employee Loans

1.    Promissory Note

Your employee should sign promissory notes. Include information on the loan's total amount and its repayment terms, such as the interest rate, the frequency of payments, and what happens if you miss a payment.

 

A promissory note is an official IOU: a formal agreement outlining how much money will be repaid between the parties. This will specify the terms of repayment for the employee, such as the total amount owed, the frequency of payments, the interest rate, and what occurs in the event of default (such as automatic deductions from the employee's paycheck or legal action if the employee quits).

 

2.    Sum borrowed

What form of difficulty qualifies as a valid justification for a loan? How much debt is this individual currently capable of taking on? Does the offer amount depend on the employee's income, position at the company, or some other factor?

 

3.    Terms of Repayment

Before their job status changes, alternate payment arrangements can be made, and loan payments can be withdrawn from the employee's wage or paycheck. The objective is to get paid on time or stop employees from leaving without carrying out their contracts.

 

4.    Interest Rates

Charge interest at least equal to the Applicable Federal Rate (or AFR) on any employee loans given by your company that exceed $10,000. The IRS determines this interest rate every month. If you don't charge this interest rate, the IRS can view it as "phantom income," which is taxable for your company.

 

5.    Terms of default

If an employee leaves the company, does the business demand full payment right away or does it negotiate new conditions to finish the debt repayment? What happens if their hours are cut, they stop paying the debt, or their employment is terminated?

 

6.    Create a written employee loan policy

It's doubtful that the first employee to request a loan will be the last if you provide one. The best location to specify who has the power to approve loans is in a formal policy. Employees will better grasp their financial possibilities and restrictions if a common policy is in place.

 

 

Planning and establishing rules for an employee loan program is best. List the conditions under which you will extend a loan and specify when you anticipate receiving repayment. A general policy can clear up any ambiguity and provide employees with accurate information. This way, you'll already have a process when an employee requests a loan.

 

7.    Keep Detailed Records of Employee Loans

To prevent loan payments made by your employee from being incorrectly classified as business income, make sure that any loans from your company are documented "on the books."

 

 

Alternatives to Employee Loans

1.    Loans for retirement plans

Employees frequently borrow money against their retirement savings through retirement plan loans. One drawback is that, unless you use the money to buy a primary property, the IRS does require employees to return a plan loan within five years and make payments at least quarterly.

 

2.    Advance on Paycheck

It's likely that your employee is in urgent need if they ask you for a loan. Perhaps they have unanticipated auto repairs, family member medical expenses, or perhaps an unexpected furnace replacement.

 

A paycheck advance might be the solution if such is the case. Giving your employees some or all of their next paycheck early limits the potential loss to one payment for your company. It is a less complicated option than an official employee loan.

 

An employee may be offered a paycheck advance, a temporary short-term cash loan that must be repaid with the borrower's following paycheck. Paycheck advances are easier to obtain than loans if the company is accommodating, and they can also offer temporary respite for cash flow issues.

 

Before Lending  Money, Ask These Questions

  • What is the financial background of my employee?
  • How does my staff handle money? Are they trustworthy with money? What purpose will they put the funds to?
  • Do I worry about getting paid back?

 

Someone who needs money because they can't budget or don't live within their means may be different from an employee who needs money for a one-time unforeseen emergency. However, remember that you may be subject to discrimination claims if you loan money to one employee but not another.

 

What Should Be in Documents for Employee Loans?

Employee loans should have the following components, similar to the initial setup of a personal loan:

 

Covenants: a formal debt agreement's contractual terms and circumstances

Guarantees: the individual or individuals accountable if the borrower defaults

Interest rate conditions The interest's annual percentage rate (APR)

Duration of repayment: a detailed description of the loan payback schedule, including the number of instalments

Standard terms: A specific strategy for late fines, unpaid debt collection, and debt collection expenses

Everyone involved: Name of the company, the borrower, and the witness's name.

Important dates: Dates on which each party signed the agreement and its effective date

 

 

This whitepaper was written by Nicholas T. Mushayi, a consultant at the Industrial Psychology Consultants. He can be contacted at [email protected]

 


Nicholas Mushayi
      View Nicholas Mushayi's full profile



Related Articles






Popular Categories














Good Reads