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 That is why U.S. retirement industry leaders talk about the prospect
of doing away with 401(k) loans before younger workers follow in the
footsteps of previous generations and start using their retirement
account like an ATM.
Workers who take out 401(k) loans risk not having enough saved for
retirement because they miss out on growth while the money is
borrowed. Some may also reduce their contributions or stop them
altogether, research shows.
Internal Revenue Service rules say you can borrow up to $50,000 or
50 percent of the account balance, whichever is greater.
This ability to cash out some portion of your retirement account
balance is unique to 401(k) plans. You cannot borrow against an
Individual Retirement Account or a pension, for instance.
The problem is with middle-aged workers, who are the heaviest loan
users, according data from the Employee Benefit Research Institute.
The overall average of loans has hovered between 18 and 20 percent
for the last few years; about 27 percent of participants in their
40s had a loan balance in 2013, the last year of EBRI's data.
Workers can take out money as withdrawals without penalty after age
59 1/2.
"New employees won't notice, but sure as heck the older ones would
notice it," said EBRI Research Director Jack VanDerhei.
Among developed countries with private retirement systems, the
United States is alone in allowing basically unrestricted access to
cash without providing proof of a hardship, according to a recent
study led by Brigitte Madrian, a professor at Harvard's Kennedy
School of Government.
In fact, loans were used to entice workers dependent on pension
plans to enroll in 401(k)s when they were introduced in 1981.
"They thought it would be hard to get people who were living
paycheck-to-paycheck to sign up unless they thought they can get
their hands on their money in a loan," VanDerhei said.
A study VanDerhei did in 2001 showed the loan option made a big
difference in how much a person was willing to contribute.
But that was before the financial crisis of 2008 and before the age
of auto-enrollment.
Today's under-40 generation does not pay much attention to the
details of retirement plans they get at work, and it is unlikely
that any change would prompt them to start opting out in huge
numbers, VanDerhei says.
HUGE CONSEQUENCES
While it is alarmingly simple to borrow from your 401(k), borrowers
may sometimes have to pay set-up fees. The low interest rate charged
is actually credited back to your own account as you repay.
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The consequences in lost growth, however, can be monumental.
Fidelity Investments estimates that a person who takes one loan out
- the average balance they see is $9,000 - is set back about 7.6
percent from his or her long-term retirement goal.
Half of Fidelity's borrowers end up with more than one loan. The
real-dollar impact is between $180 and $650 a month in retirement,
according to the company's estimates.
It is not just the loan balance that affects the retirement account.
Of the 20 percent who borrow, Fidelity has found that 25 percent
lower their savings rates within five years of taking a loan, and
another 15 percent stop saving altogether while the debt is
outstanding.
"We take these calls, millions of calls every year," said Jeanne
Thompson, a Fidelity vice president. "We see they have taken loans,
and they don't have enough to retire."
A direr problem is with those who have an outstanding balance when
they lose or change jobs. They must repay their loans immediately or
face tax penalties on top of credit problems.
"The vast majority of money is actually repaid, on the order of 85
percent of it," says Harvard's Madrian. "But for a smaller subset of
people, it can be a problem."
Legislation to change 401(k) loan provisions is unlikely at this
point, Madrian said.
"It would be easier if you had some companies get rid of the option
and show the employees were better off," she said. "Absent some more
compelling data, it's going to be hard to shift the policy landscape
on that front."
(Editing by Lauren Young and Lisa Von Ahn)
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