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High loan rates may signal a need for household budgeting and debt-management advice
Loan activity in 401(k) and other defined contribution plans was little changed in 2014 from the previous year but continued to remain elevated compared with six years ago, before the 2008-09 Great Recession, according to a February 2015 report on Defined Contribution Plan Participants’ Activities.
The study by the Investment Companies Institute (ICI), an industry group, revealed that 18 percent of defined contribution (DC) plan participants had loans outstanding at the end of September 2014, compared with 18.2 percent at year-end 2013 and 15.3 percent at year-end 2008.
The study, based on recordkeeper data covering about 25 million participant accounts, also showed that:
• Most DC plan participants stayed the course in their asset allocations. In the first three quarters of 2014, as stock values generally rose, 8.1 percent of DC plan participants changed the asset allocation of their account balances and 5.6 percent changed the asset allocation of their contributions—slightly lower than the reallocation activity observed in the first three quarters of 2013.
• Participants generally did not tap their accounts. Only 3.1 percent of DC plan participants took withdrawals in the first three quarters of 2014, similar to the pace observed over the first three quarters of 2013. Only 1.4 percent took hardship withdrawals during the first three quarters of 2014, the same share as in the first three quarters of 2013.
According to the ICI, assets in all DC plans represented more than one-quarter of assets in the total retirement market and accounted for one-tenth of U.S. households’ aggregate financial assets at the end of the third quarter of 2014.
Fostering Financial Wellbeing
Plan sponsors with participant loan and withdrawal rates considerably higher than the average may want to consider offering their employees tools and educational resources to help them to improve their budgeting skills and increase their ability to save.
A study by the Society for Human Resource Management last year showed that workers are looking to their employers for help managing their overall financial wellness. Among HR professionals who indicated their organization provides financial education, 72 percent reported the financial education initiative has been somewhat or very effective in improving their employees’ financial wellbeing.
Employers that consider themselves to be “innovators” are more likely than others to have tools in place to assist their employees with improving their financial wellness, according to a February 2015 report by Aon Hewitt. In particular, they are taking actions to keep as much money as possible in the plan, which includes discouraging participants from taking loans against their accounts or making hardship withdrawals, when avoidable.
To achieve this, innovative employers are offering tools, services and education to help their workers develop sounder financial practices.
Prevalence of Financial Wellness Services
Type of Service
Offered by Employers Seen as ‘Innovators’
Offered by Other Employers
Basics of investing
Saving for life stages
Source: Aon Hewitt, Inspired by Innovation: The Actions Early Adopters Are Taking in Their DC Plans
Similarly, recent TD Ameritrade survey showed that financial disruptions cost Americans $2.5 trillion in lost retirement savings, and that developing good savings habits and financial literacy were key to recovery. Baby boomers who had successfully prepared for retirement said the top three things that contributed to their success were:
• Limiting use of credit (67 percent).
• Saving early and consistently (58 percent).
• Spending less on luxuries/discretionary items (58 percent).
“While no one can predict when, or if, a financial disruption will occur, the key is to focus on what can be controlled,” advised Lule Demmissie, managing director of retirement at TD Ameritrade.
High Cost of 'Leakage': Other Views
As 401(k)s have become the dominant source for employer-provided retirement saving, the potential for “leakages”—in-service withdrawals for hardships or pre-retirement loans that aren't repaid—has grown, according to a February 2015 issue brief from the Center for Retirement Research at Boston College.
Estimates indicate that each year about 1.5 percent of assets leak out of 401(k)s, along with pre-retirement withdrawals from individual retirement accounts, reducing wealth at retirement by about 25 percent.
The brief advises limiting hardship withdrawals to unpredictable events, among other reforms.
Loan Repayment Isn't Enough
“Should 401(k) loans be viewed as a plan outflow if they are repaid?,” asked a February 2015 viewpoint by BMO Global Asset Management, which answered:
We think they should be. Loans taken from plans that permit them are issued to participants in pre-tax dollars but are repaid with after-tax dollars. And after the participant retires, those dollars are taxed again when distributed from the plan.
Furthermore, interest rates paid on outstanding loan balances are low. As a result, the Employee Benefits Research Institute projects that participants who cease making salary deferrals during the loan period erode retirement income by 10 to 13 percent.
BMO Global’s advice to plans sponsors includes:
• Restrict participant loans. Allow one loan at a time, for serious financial hardships only.
•Negotiate with your service provider. Allow participants to make loan repayments after they separate from service.
• Develop targeted communications. Address the negative impacts of in-plan loans, taking hardship distributions and cashing out of the plan.
• Automatically restart participant contributions. Do this six months after issuing a hardship distribution.
• Amend the plan. Allow partial distributions by plan participants and permit new employees to roll over existing loans from prior providers.
Stephen Miller, CEBS, is an online editor/manager for SHRM. Follow him on Twitter @SHRMsmiller.
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