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‘Breaching’ Out?

“401(k) breaches undermining retirement security for millions,” read the headline of a recent article in the Washington Post. No, we’re not talking about some kind of data-hacking scandal or new identity theft breach. Rather, those “breaches” are loans and withdrawals from 401(k) plans. Providing the impetus for the article was a report by HelloWallet indicating that, “more than one in four workers dip into retirement funds to pay their mortgages, credit card debt or other bills.”

Off the Mark on Loans

The Post article noted that the “most common way Americans tap their retirement funds is through loans,” although U.S. Department of Labor data indicate that loan amounts tend to be a negligible portion of plan assets and that very little is converted into deemed distributions in any given year. That finding is supported by hard data from the EBRI/ICI 401(k) database, the largest micro-database of its kind: Among participants with outstanding 401(k) loans in the EBRI/ICI database at the end of 2011, the average unpaid balance was $7,027, while the median loan balance outstanding was $3,785. (For an updated report on participant loan activity from the EBRI/ICI database, see “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2011.”

Interest Payments

The article also cautioned that loans “must be repaid with interest,” but failed to mention that the 401(k) participant is paying interest to his/her own account: Those repayments represent a restoration of the retirement account balance by the participant, as well as a return on that investment. Sure, those interest payments are coming from participants’ own pockets, but they’re generally being deposited into their own retirement accounts, and (if a loan is being used to pay down debt) probably at a much more favorable rate of interest.

Withdrawal Penalties

The article also noted that those who withdraw money from their 401(k)s early (that is, before the authorized age) face “hefty” penalties, and certainly, as advisors know, there is a financial price. However, those penalties consist of the 10% early withdrawal penalty (which was put in place long ago to discourage casual withdrawals by those under age 59-1/2), and the income taxes they would be expected to pay on the receipt of money on which they had not yet paid taxes (which they would likely pay eventually).

The article quotes the HelloWallet author as noting that, “What you have is 401(k) participants voting with their wallets saying they would much rather use this money for other purposes.” However, these reports can’t always know, and thus don’t consider, how many participants and their families have been spared true financial hardship in the “here-and-now” by virtue of access to funds they set aside in these programs. (I wrote about this last July, here.) For example, an AonHewitt study cited in the article and the HelloWallet report notes that just over half of the hardship withdrawal requests were to avoid home eviction or foreclosure.

Ignoring the Unknown

As much as advisors may caution workers about the impact of drawing out these funds before retirement, it’s hard to know how many of these “breachers” would have committed to saving at the amounts they chose, or to saving at all, if they — particularly the young with decades to go until retirement — had to balance that choice against a realization that the funds they set aside now would be unavailable until retirement. Nor can we know that individuals who chose to save in their 401(k) plan did so specifically for retirement, rather than for interim (but important) savings goals like home ownership or college tuition. Indeed, those investments, sooner or later, make their own contributions to retirement security. In fact, what appears to a be a short-term decision that might adversely affect retirement preparation may actually be a long-term decision to enhance retirement security with a mortgage paid off or higher earnings potential.
In sum, we don’t know that these decisions represent a “breach” of retirement security — or a down payment.

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