CHICAGO (Reuters) - Americans could dig a $2.5 trillion hole in the
country’s retirement system as they fail to pay back loans taken from workplace
retirement plans over the next 10 years, according to a new study from Deloitte
The problem is called “leakage” - borrowing from a 401(k) plan without
repaying the money or paying it back so slowly that it disrupts growth.
About 40 percent of people borrow from workplace plans. Most repay their
loans within five years with interest, which is a typical requirement. But
academic studies have found that about 10 percent default; often when laid off,
which recalls the loan immediately. If you cannot repay the balance in cash, it
counts as an early withdrawal, subject to taxes and penalties.
An additional problem is that two-thirds of people cope with that payback
issue by pulling out the entire balance from their 401(k)s, according to
The result for a typical 42-year-old borrower, taking out a $7,000 loan
from a $70,000 account: $300,000 less at retirement age than they would have
had if they had never touched the money and investments gained 6 percent a
“People absolutely do not realize the consequences,” said Deloitte senior
manager Gursharan Jhuty.
The financial industry has done little to plug the leaks. Instead, the
focus of employers, fund companies and 401(k) administrators has been on
getting people to save more. During the first half of this year about 55
million Americans had 401(K) accounts with a total of $5.3 trillion, according
to the Investment Company Institute.
Loans are available in about 90 percent of plans because research indicates
that people are more comfortable saving when they know they can withdraw money
in a pinch.
People with incomes below $30,000 account for 22 percent of the borrowing,
with 10 percent by people earning over $100,000, according to Vanguard. People
borrow to deal with emergencies such as medical expenses or try to get rid of
the pressures of other loans such as high-cost credit card debt. They also pull
money to buy or renovate homes or for college tuition.
Here are some strategies experts think could help stop the drain:
1. BORROW ONCE
Companies often require that employees have no more than one loan
outstanding at a time, but Deloitte suggested they might also limit employees
to an ongoing limit on loans.
Financial planners such as Charles Adi of Houston, Texas said he was
comfortable with a single loan to pay off high credit card debt if the person
does not add debt again and keeps saving. “I have them cut up their credit
cards in my office,” he said.
It is also crucial before borrowing to examine whether a job is secure or
whether there is another source of funds that could be used to pay back the
loan if a layoff occurs.
2. LIMIT USE
Using a 401(k) loan for a home downpayment or maintenance can make sense
provided jobs are secure, said White Plains New York financial planner Byrke
Sestok. Yet, he and others discourage the use for college: “I tell them to have
their child consider a less expensive school.”
3. SOLVE FINANCIAL PROBLEMS
Increasingly, companies are offering employees financial wellness programs
to help with debt management and budgeting – practices that could keep them out
of a financial bind in the first place if they use the advice.
In addition, Deloitte suggested employers require employees to get
counseling before taking loans so they understand the impact of a lost job or
the damage the loans could do to their retirement.
But counseling often comes too late, noted Kelley Long, a Financial Finesse
financial planner who takes hotline calls from employees required to talk to
advisers before pulling money from the 401(k).
At the point that people call in to a financial services company to discuss
the loan terms, “it’s too late to fix the problem that led to the loan,” Long
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