Fears of Increased ‘Leakage’ Drive Efforts to Insure, Toughen Retirement Plan Borrowing

Concerns are mounting in the United States about the increase in retirement plan “leakage” — hardship early withdrawals and loans being taken against such plans during tough economic times. As more Americans deplete their retirement savings to meet emergency expenses resulting from long-term unemployment, tightened credit or high medical expenses, policy makers are seeking ways to stem the flow.

Money withdrawn for crisis spending is rarely replaced in workers’ retirement plans and studies have found a rising rate of default on retirement savings loans. The Investment Company Institute estimates that the portion of 401(k) participants obtaining loans against these funds increased from 15 percent in 2006 to 18.5 percent in 2011. Employees are also prone to spend some of the money available to them when switching jobs and rolling their retirement funds over into an individual retirement account or new employer-sponsored 401(k), another factor that threatens retirement readiness for many.

Among the steps being proposed to address this drain on retirement savings is requiring employees seeking such loans to purchase insurance to protect those savings if they default on the outstanding loan amount because of disability or death. The retirement fund loan insurance idea has gained enough steam that a bill that would require corporate pension borrowers to auto-enroll in such insurance has been proposed in the U.S. House of Representatives by Rep. Pete Sessions, R-Texas.

Introduced in late 2011, the “Retirement Savings Security Act” would treat the loan insurance like private mortgage insurance, which banks often require of some borrowers before extending a home loan. In this case, though, borrowers would be charged for insurance on money that they will repay to themselves, not a lender. Employees would be allowed to opt out of automatic enrollment.

Another congressional proposal, in the Senate, is designed to combat leakage by making it harder for workers to take out 401(k) loans but easier to pay them back. The “Savings Enhancement by Alleviating Leakage in 401(k) Savings Act,” or SEAL Act, was introduced by Sens. Herb Kohl, D-Wisc., and Mike Enzi, R-Wyo., in May 2011. The bill would reduce the number of loans that 401(k) participants can take to three at a time. Currently, employers determine the number of loans available.

For more information on 401(k) loans, withdrawals and distributions, see Thompson’s employee benefits library including the Pension Plan Fix-It Handbook.