Defined contribution plan participants who take out plan loans are more likely saving at a lower contribution rate than most, and are not likely to repay the loan when they leave their employer. This according to a new report based on research from New York Life Retirement Plan Services’ DC data. With those factors in mind, the large plan service provider encourages plan sponsors not to push loan access as a feature to attract more employee plan participants.
The first annual study of the “State of the Retirement Industry” by New York Life attempts to dispel several similar, widely held beliefs about 401(k)s and their participants’ savings behavior. For example, it tries to temper the belief among some sponsors that providing a pipeline to employees’ 401(k) money is critical in order to get them to participate in the sponsor’s retirement plan.
“Access is not critical, but leakage is a crisis. A comparison of 401(k) plans on our defined contribution platform show a difference of less than 10 percent[age points] in participation for plans that have loans compared to those that don’t. Rare is the participant that takes an in-depth look at the plan features when making the decision to participate (or to opt out of participating) in the 401(k) plan,” the report says. Leakage refers to hardship withdrawals, loans or cashouts upon departure from a job, all actions that whittle away at retirement savings for those using the money during their working years.
Loans have far-reaching implications, both for plan sponsors and participants. The average contribution rate for a participant with a loan is 5.63 percent, compared with 7.23 percent for those participants without a loan, New York Life said in an Aug. 1 press release about the report. In addition, more than two-thirds of participants with an outstanding loan balance who leave an employment end up taking a distribution rather than paying the loan back, according to the service provider’s statistics.
“So this begs the question, why do we offer them? The answer, of course, is because the person is often in dire straits and needs financial help. Yet 401(k) loans only ease a symptom rather than address the problem, and there needs to be better scrutiny in how employers help participants solve these financial problems,” New York Life said. The company said its analysis found average participation rates for plans without loans to be 67 percent, just 9.6 percentage points lower than those plans that offer loans and have average 76-percent participation. The service provider does not advocate eliminating loans entirely, but it does suggest “the number and size of loans available to participants should be limited in scope.”
“As an industry, we need to reverse the ATM mentality that has developed around 401(k) savings by encouraging sponsors to rethink loans from a plan design perspective, and enabling participants to differentiate between everyday, emergency and retirement savings,” Rachel Rice, managing director of marketing and product development for New York Life Retirement Plan Services, said in the news release.
To read the complete story on Thompson’s HR Compliance Expert, click here.
When you write about loans from 401(k) plans, it would be better if you balanced the opinions of service providers who have a financial conflict of interest with that of a plan sponsor or two. Apparently, NY Life, Fidelity and others have all decided to challenge loan provisions at this time – must be losing fee revenue from reductions in assets under management.
Each article on loans typically recounts one or more of the challenges a participant faces when they access assets prior to retirement in the form of a loan:
• Failure to repay the loan, almost always following termination, almost never while remaining employed,
• Failure to reallocate remaining assets to maintain equity investment exposure, and
• Contributing a smaller percentage of pay.
The recommended actions include:
• Limiting borrowers to one loan at a time,
• Allowing participants to repay 401(k) loans even after a job change, and
• Limit the size and scope of loans (e.g., maximum 25% of vested account balance).
Some other myths about 401(k) loans commonly found in other articles:
• Loans depress accumulations of plan assets,
• Loans are not tax efficient as repayments are made on an after tax basis and trigger “double taxation”,
• Loans are just another form of withdrawals, and
• Participants would be better off if they sourced debt from commercial sources.
However, the facts are that:
(1) Reasonable access via loans is not leakage – and certainly not leakage compared to payouts at job change or in-service hardship withdrawals.
(2) Service providers would do us all a favor if they spent as much time updating their 401(k) loan processing, to take it to 21st century standards, as they do trying to limit loans and discourage plan sponsors from offering this access – in fact, those who complain the loudest are likely to be those who also fail to invest in processes and technology that would best ensure the loan is repaid.
(3) Interest on loans is just as tax preferred as earnings on other assets (except perhaps certain employer securities) – where secured with a mortgage, it may be tax deductible, where secured with Roth assets, it may be tax free upon distribution.
(4) Those who borrow from the 401(k) are:
– likely to have a lower interest rate than a commercial loan,
– won’t suffer a loss of investment income if they remember to rebalance their account to take account of the increased fixed investment (the loan), and
– are likely to be saving more than those who take loans from commercial sources.
(5) Studies show, for those who are in debt, that they would likely be better off (both in terms of wealth in the 401(k) plan and wealth outside of the 401(k) plan) if, instead of a commercial loan, if they borrowed from the 401(k).
Get some balance in your reporting – talk to a few plan sponsors. Same applies to your new post about automatic enrollment and the Boston College Center for Retirement Research.