A loan from your 401(k) plan has well-known drawbacks, among
them the taxes and penalties that may be due if you lose your job and can’t pay
off the loan in a timely way. But there is a subtler issue too: millions of
borrowers cut their contribution rate during the loan repayment period and end
up losing hundreds of dollars each month in retirement income, new research
shows.
Academics and policymakers have long fixated on the costs of
money leaking out of tax-deferred accounts through hardship withdrawals,
cash-outs when workers switch jobs, and loans that do not get repaid. The
problem is big. Some want more curbs on early distributions and believe that
funds borrowed from a 401(k) should be insured and that the payback
period after a job loss should be much longer.
Yet most people who borrow from their 401(k) plan manage to
pay back the loan in full. A more widespread problem is the lost savings—and
decades of lost growth on those savings—that result when plan borrowers cut
their contribution rate. About 40% of those with a 401(k) loan reduce
contributions, and of those a third quit contributing altogether.
Nearly one million workers in a Fidelity administered 401(k)
plan initiated a loan in the year ending June 30. That’s about 11% of all its
participants and part of rising trend, the company says. The typical loan
amount is $9,100 unless the loan is to help with the purchase of home—in that
case the typical amount borrowed is $23,500.
These figures are generally in line with data from
the Employee Benefit Research Institute, which found that the typical unpaid
loan balance in 2012 was $7,153 and that 21% of participants eligible for a
loan had one outstanding. The loans were relatively modest, representing just
13% of the remaining 401(k) balance.
Workers change their contribution rate for many reasons,
including financial setbacks and a big new commitment like payments on a car or
mortgage. But cutting contributions to make loan payback easier may be the most
common reason—and the least understood cost of a 401(k) loan.
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