“Breaching” Out?

“401(k) breaches undermining retirement security for millions,” was the headline of a recent article in the Washington Post.(1) No, we’re not talking about some kind of data hacking scandal, nor some new identity theft breach. Rather, those “breaches” are loans and withdrawals from 401(k)s.

Providing the impetus for the article is a new report by HelloWallet(2) that indicates that “more than one in four workers dip into retirement funds to pay their mortgages, credit card debt or other bills.”

While the article primarily deals with the potentially negative aspects of loans and withdrawals, it also touches on some broader concerns—and does so with some factual inaccuracies. For example, the article incorrectly states that “in 1980, four out of five private-sector workers were covered by traditional pensions;” in fact, only about half that many actually were at that point (a correct statement would be that 4 out of 5 covered by a plan at that time were in a traditional pension, which works out to about 2 in 5 of all private-sector workers—which puts the article’s “now, just one in five workers has a pension” statement in a far more accurate context).

The article notes that the “most common way Americans tap their retirement funds is through loans,” although U.S. Department of Labor data indicate that loan amounts tend to be a negligible portion of plan assets and that very little is converted into deemed distributions in any given year. That finding is supported by hard data from the EBRI/ICI 401(k) database, the largest micro-database of its kind: Among participants with outstanding 401(k) loans in the EBRI/ICI database at the end of 2011, the average unpaid balance was $7,027, while the median loan balance outstanding was $3,785.(3)

The Washington Post article cautions that these loans “must be repaid with interest,” but fails to mention that the 401(k) participant is paying interest to his/her own account: Those repayments represent a restoration of the retirement account balance by the participant, as well as a return on that investment. Sure, that interest payment is coming from the participant’s own pocket, but it’s generally being deposited into their own retirement account, and (if it was being used to pay down debt) likely at a much more favorable rate of interest.

The article also notes that those who withdraw money from their 401(k) early (before the authorized age) face “hefty” penalties, and certainly there is a financial price. However, those penalties consist of the 10 percent early withdrawal penalty (that was put in place long ago to discourage casual withdrawals by those under age 59 -½), and the income taxes they would be expected to pay on the receipt of money on which they had not yet paid taxes (which they would likely pay eventually).(4)

The HelloWallet report describes defined contribution (DC) retirement plans as a “marginal contributor to the actual retirement needs of U.S. workers.” However, an EBRI analysis of the Federal Reserve’s Survey of Consumer Finance (SCF) data, looking at workers who are already retired, finds that DC balances plus IRAs—which for many retired individuals were funded by rollovers from their DC/401(k) plans when they left work—represent nearly 15 percent of their total assets (which includes things like houses, but does not include Social Security and defined benefit annuity payments, although DB rollovers are included), and nearly a third of their total financial assets, as defined in the SCF.

The dictionary describes a “breach” as an “infraction or violation of a law, obligation, tie, or standard.” The article quotes the HelloWallet author as noting that “What you have is 401(k) participants voting with their wallets saying they would much rather use this money for other purposes.” However, these reports can’t always know, and thus don’t consider, how many participants and their families have been spared true financial hardship in the “here-and-now” by virtue of access to funds they set aside in these programs(5) (an AonHewitt study,(6) cited both in the article and in the HelloWallet report, notes that just over half of the hardship withdrawal requests were to avoid home eviction or foreclosure).

It’s hard to know how many of these “breachers” would have committed to saving at the amounts they chose, or to saving at all, if they (particularly the young with decades to go until retirement) had to balance that choice against a realization that the funds they set aside now would be unavailable until retirement. We don’t know that individuals who chose to save in their 401(k) plan did so specifically for retirement, rather than for interim (but important) savings goals—such as home ownership or college tuition—that, sooner or later, make their own contributions to retirement security. Indeed, what appears to a be a short-term decision that might adversely affect retirement preparation may actually be a long-term decision to enhance retirement security with a mortgage paid off or higher earnings potential.

In sum, we don’t know that these decisions represent a “breach” of retirement security—or a down payment.

Nevin E. Adams, JD


(1) The Washington Post article is online here.

(2) You can request a copy of the HelloWallet report here.

(3) For an updated report on participant loan activity from the EBRI/ICI database, see “401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2011,” online here.

(4) While the Post article states that these taxes would be paid at capital gains rates, in fact, withdrawals are taxed as ordinary income.

(5) See “’Premature’ Conclusions,” online here.

(6) See “Leakage of Participants’ DC Assets: How Loans, Withdrawals, and Cashouts Are Eroding Retirement Income 2011,” online here.