Borrowing from retirement savings
To SUSTaIn hoMe anD FaMILy In ReTIReMenT, four
elements are crucial: Social Security, employer-sponsored retirement
plans, personal savings, and work after retirement. But for retirees
who want to augment those sources of income, what are the options?
Private individuals can’t personally expand their Social Security and
employer-controlled retirement plans
or, beyond a certain point, their work
in retirement. But they can increase
their personal savings, especially those
in employer-sponsored 401(k), 403(b),
and 457 plans (and, possibly, automatic
IRAs). The most important way to encourage retirement savings, cost free
to the employer, is to allow individuals
tax-free access to their retirement savings as a loan.
Most individual account retirement
plans allow for loans. Depending on the
study you consult, 80 percent to 90 percent of participants in these qualified
retirement plans are in plans that allow
for loans. Formal studies in both the
private and the public sector have demonstrated that the existence of a loan
provision in a plan increases employee
retirement savings, with employees citing the comfort they take in knowing
their retirement funds are available in
the case of an emergency. An October
1997 study of loan provisions and 401(k)
plans, conducted by the Government
Accountability Office, indicated that average annual contribution amounts are
35 percent higher in 401(k) plans with
loan provisions compared with those
without loan provisions. A 2004 LIMRA
study confirmed that an increase does
occur with availability of loans, albeit
by only 21 percent.
Most plan participants, especially
those who don’t have access to a home-
equity loan or a margin securities
account loan, borrow through credit
cards, which have significantly higher
interest rates. Consolidating those debts
through a loan from a retirement plan
reduces the cost of borrowing and frees
up funds to enhance savings.
One of the most valuable and
attractive options that the 401(k)
(type) program(s) has sanctioned
is that of permitting plan sponsors
to allow 401(k) and 403(b)
participants to invest a portion of
their capital in a temporary loan
to themselves. This facility has the
effect of increasing the liquidity
of the capital accumulated in the
account, making the accumulation
much more affordable and
attractive, especially for young
But there are disadvantages to mak-
ing loans available out of retirement
savings. Significant leakage from re-
tirement savings accounts can occur
when a plan participant terminates
employment. If the participant has a
loan in place at that date, he or she is
compelled to repay the loan or suffer
a burdensome tax. Other arguments
against the practice include concerns
that the participant will stop making
contributions to the plan while his or
her loan is in effect, that the participant
will be taxed twice since he or she is
paying back the loan with after-tax dol-
lars, and that more access to credit will
necessarily mean greater debt for the
plan participant.
overlooked Advantages
I believe, however, that the positives
outweigh the negatives. In addition to
potentially encouraging savings, the
default of a loan causes a de minimis
loss of retirement savings because the
defaulted loan wasn’t a loss but was
enjoyed pre-retirement. Transferring
high-interest debt into a loan from a
DReaMSTIMe
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