Borrowing from 401(k)s Hits Retirement Income Hard

Millennials borrowed 37% of their retirement savings for new home loans

By Stephen Miller, CEBS Oct 9, 2014

Nearly 1 million 401(k) participants initiated a loan from their accounts during the year ending June 30, 2014, according to an October 2014 analysis by Fidelity Investments.

After taking a loan, 40 percent of borrowers decreased their savings rate in 401(k) plans administered by Fidelity, and more than a third of those stopped saving altogether.

There are long-term consequences for participants who stop contributing to their plan, including the potential loss of up to hundreds of dollars in monthly retirement income, depending on the reduction in savings and how long participants save at the reduced rate.

To illustrate this, Fidelity conducted a hypothetical analysis of three 401(k) investors who started saving at age 25 with a 6 percent employee contribution and a 4 percent employer contribution (for a 10 percent total savings rate), and assumed an annual salary of $50,000. The analysis looked at three separate savings scenarios starting at age 35.

The table below demonstrates the estimated monthly retirement income from their 401(k) accounts for these hypothetical investors.

Initial Savings Rate

New Savings Rate and 
Length of Change

Estimated Monthly 401(k) Retirement Income

10%

Reduced to 0% for 10 years

$1,960

10%

Reduced to 5% for 5 years

$2,470

10%

Maintained at 10% for 10 years

$2,650

Borrowing to Buy a Home

In the year ending June 30, more than 27,000 investors took loans from their retirement accounts specifically for the purchase of a home, a trend Fidelity has seen increasing over the past five years. The firm’s analysis revealed that:

Today’s average 401(k) home loan is $23,500, far higher than the average general loan value of $9,100. It represents 25 percent of an average borrower’s 401(k) pre-loan balance versus 17 percent for a general loan.

Millennials (born 1979-1991) borrowed on average 37 percent, or $17,100, of their retirement savings balance for a home. According to Fidelity, “borrowing so much at this young age could be a stretch for people who are also taking on a mortgage and might be saddled with student debt.”

A greater portion of Generation X participants (born 1965-1978) took 401(k) home loans than Millennials or Baby Boomers (born 1946-1964), averaging $25,600 or 26 percent of their balance. “Borrowing a quarter of a person’s balance during these crucial income years makes it all the more difficult to stay on track with retirement savings if they reduce or stop saving,” according to a Fidelity savings rule of thumb that advises, “Generation X should have at least a full year’s salary saved for retirement at age 35 and three years at 45.”

Additional Loan Implications

HR benefit managers are advised to inform potential borrowers of these additional implications before taking a 401(k) loan:

Job changing. If moving to a new job, any outstanding 401(k) loan balance typically must be repaid within 60 days. Plan rules may vary, so make sure participants are aware of their plan-specific details.

Savings rate. Borrowers unable to continue saving at the same pre-loan rate while repaying their loan may adversely impact their monthly retirement income.

Tax implications. Loans are paid back with after-tax dollars, which can negatively impact the tax-deferred savings benefits of a 401(k).

Despite these caveats and drawbacks, there may be times when a 401(k) loan is a useful, or perhaps the least-bad, option as long as plan participants carefully weigh all their alternatives and understand the possible implications.

Stephen Miller, CEBS, is an online editor/manager for SHRM. Follow him on Twitter @SHRMsmiller.

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