Multiplication ‘Fables’

Did you hear the one about loan defaults adding up to $2.5 trillion in potential retirement savings shortfalls over the next 10 years? How about the “$210 Billion Risk in Your 401(k)”?

Those reports were based on an “analysis” by Deloitte that claims to find that “…more than $2 trillion in potential future account balances will be lost due to loan defaults from 401(k) accounts over the next 10 years…” That’s right, $2 trillion lost “due to loan defaults” (the Wall Street Journal apparently picked the figure that matched the impact on a “typical 401(k) borrower” – more on that in a minute).

Now, when you see headlines putting a really big number on what you already suspect is a problem – in this case “leakage” – roughly defined as a pre-retirement withdrawal of retirement savings – well, you could hardly be blamed for simply accepting at face value the most recent attempt to quantify the impact of the problem.

A closer look at the assumptions behind that analysis, however, puts things in a different light.
The Deloitte paper leads with the question “How can we keep loan defaults from draining $2 trillion from America’s 401(k) accounts?” – but despite the positioning of the premise that this is a leakage issue, the loan default turns out to be only a small part of the problem.

The Deloitte authors outline the assumptions underlying their conclusions in the footnote of the 12-page document. Specifically, they draw many of their starting points from a 2014 study, “An Empirical Analysis of 401(k) Loan Defaults,” which found that with 86% of the participants that terminated employment with loans outstanding defaulted on those loans – and took their entire account balance out at the time of loan default. That report also noted that the average age¹ of the loan defaulter was 42. The Deloitte authors also draw from Vanguard’s “How America Saves 2018” that the average loan default was approximately 10.1% of the total account balance.

And then, with that as a foundation, the Deloitte authors begin to build.

The Deloitte modeling assumption relies on the notion that the vast majority of participants who default on these loans take their whole balance out of the plan. Rather than using the 86% assumption from the 2014 study, they scaled it back to a more conservative assumption that (only) 66% of participants that defaulted on their loan also took their entire account balance. They then back into the total account balance that those individuals would ostensibly have ($47.8 billion, assuming that their loan is 10% of their total balance) that they claim, based on the earlier assumptions, would be withdrawn in addition to the outstanding loan amounts. They then project growth in those totals assuming that everyone in that group is 42 (the average age of a loan defaulter) all the way out to age 65, assuming a 6% return over that period – and wind up with $2.5 trillion!

Now, there are so many assumptions imbedded in that calculation – and so many that act as multipliers on the original assumptions – it’s hard to know where to start.

To put it in individual terms, the Deloitte analysis assumes that every borrower is 42 years old, that two-thirds of these that default not only do so on a loan of $7,081 (the average outstanding loan amount), but go on to cash out their remaining account balance of $70,106 (assuming, of course, that the loan amount is approximately 10% of the balance). They then assume – and this is the assumption based on complete speculation – that there was no subsequent rollover, nor any renewal of contributions anywhere over the rest of their working lives – while also assuming that they could have attained a 6% return on those monies over that extraordinary period of time if only they hadn’t cashed out.

Still with me?

What’s obvious is that the bulk – indeed, the vast majority – of that projected impact comes not from the highlighted loan defaults – which are, in fact, a mere fraction of the terminating participants’ 401(k) balance – but from what the Deloitte authors term the “leakage opportunity cost” – basically it’s the “magic” of compounding applied to both the defaulted loan and the other 90% of the participant account balance… at a 6% rate of return over nearly a quarter century.

They say that two “wrongs”² don’t make a right – and that’s particularly true when multiplication is involved.

It’s not that the math isn’t accurate. It’s just that the answer doesn’t “figure.”

Nevin E. Adams, JD

1. There are always potential problems with extrapolating conclusions from averages. That said, the 2014 study from which those averages are drawn note that participants who defaulted on their loan were more likely to have larger loan balances than those who repaid, and to have lower household incomes and smaller 401(k) balances – in sum, not exactly “average.” ↩
2. The paper also makes some curious comments about loans and fiduciary liability – but we’ll deal with those in a future post. ↩

5 Things You May Not Know About Roth 401(k)s

I made the switch to Roth for my retirement savings years ago – and I have long counseled younger workers, who were likely paying the lowest tax rates of their working lives, to do so as well.

Pre-tax treatment has, of course, been the norm in 401(k) plans since their introduction in the early 1980s. On the other hand, the Roth 401(k) wasn’t introduced until the Economic Growth and Tax Relief Reconciliation Act of 2001, and even in that legislation wasn’t slated to become effective until 2006 (and at that time was still slated to sunset in 2010).

Despite that late start, according to a variety of industry surveys (Plan Sponsor Council of America, Vanguard, PLANSPONSOR), roughly 60% of 401(k) plans now offer a Roth 401(k) option, and PSCA data shows that 28.6% of 403(b) plans already allow for Roth contributions. Participant take-up, which just a few years ago hovered in the single digits, is now in the 15-20% range.

Here are five other things you may not know about the Roth 401(k):

To allow designated Roth contributions, a plan also has to offer traditional pre-tax 401(k) contributions. 

A plan can only offer designated Roth contributions if it also offers traditional, pre-tax elective contributions. Oh, and they can be offered by either a 401(k), 403(b) or 457 plan.

You can auto-enroll designated Roth contributions. 

The plan must state how the automatic contributions will be allocated between the pre-tax elective contributions and designated Roth contributions.

You can “catch up” on a Roth basis. 

Individuals can make age-50 catch-up contributions as a designated Roth contribution to a designated Roth account.

You have to include Roth contributions in the 401(k) plan annual nondiscrimination testing. 

Designated Roth contributions are treated the same as traditional, pre-tax elective contributions when performing annual nondiscrimination testing. Moreover, just like other elective deferral, they must be included when calculating the top-heavy ratio each year. You cannot allocate forfeitures, matching or any other employer contributions to any designated Roth accounts.

You can take loans from designated Roth accounts. 

As long as the plan permits, you can identify from which account(s) in your 401(k), 403(b) or governmental 457(b) plan you wish to draw your loan, including from a designated Roth account.

Retirement plan education has long had as a basic tenet that individuals will be paying lower tax rates in their retirement future. Of course, tax rates – and future income levels – are hard to predict. Both can rise more than anticipated in the future – and a Roth option can provide some essential flexibility to diversify tax treatment, as well as investments.

- Nevin E. Adams, JD

For more information, see Retirement Plans FAQs on Designated Roth Accounts from the IRS.

3 (More) Pervasive Retirement Myths - an Academic Perspective

Last week I highlighted three “myths” about the retirement system that will not die — all the more distressing because they are perpetuated by retirement industry pundits. Here are three more that (mostly) aren’t perpetuated by those who actually work with retirement plans, but by academics.  Academics who, sadly, are often listened to, and cited by those who regulate and legislate these programs.

The Match Doesn’t Matter

This doubtless comes as a surprise to those of us who work with retirement plans and retirement plan participants. More precisely, there are a few studies out there that suggest that a matching contribution doesn’t have a very strong impact on participation. The study that is cited most often in support of this one is one conducted several years ago in conjunction with H&R Block, where individuals were offered a financial incentive to take their tax refund and deposit it in an IRA. Most didn’t — and thus the notion that the promise of the match doesn’t produce (much) in the way of participation.

Now, if you find yourself saying, “But that’s not really an analogous situation to 401(k) saving” — well, you wouldn’t be the only one to think so.

But even if it has only a modest impact on the decision to participate, the data clearly suggests that it has a big impact on the rate of savings — and on the savings accumulations itself.

You Can Plug the Leakage Problem by Limiting Loans

Preventing “leakage” has become a constant drumbeat of many in our industry, their passion fueled by estimates of the enormity of the problem that seem limited only by the imaginations of those clamoring to solve it. As recently as a week ago, I was at a conference where a respected researcher went so far as to suggest that we are losing as much as $1 in leakage for every $2 contributed into the system. I kid you not.

Now, the “out” for these wild exaggerations is that nobody knows for sure, and so — if you’re looking for them — you see those estimates footnoted with disclaimers like “author’s calculations.” Or sometimes they come right out and admit that it’s based on a “host of simplifying assumptions.”

Don’t get me wrong — “leakage” can be a threat to an individual’s retirement security. But when the nonpartisan Employee Benefit Research Institute (EBRI) looked into the matter in testimony provided to the ERISA Advisory Council last year, it was cashouts — not loans or hardship withdrawals (even including the impact of a six-month suspension of contributions) — that turned out to be approximately two-thirds of the leakage impact.

So, if you want to solve the real leakage problem, you might want to start by accurately assessing the size of the problem, rather than just making numbers up. And then you might look for ways to make it easier for folks to keep their savings in the system at job change.

And let’s not forget — locking people’s money up with no access until retirement may solve the leakage problem. But it could also lead to a reduction in the amount of money people save in the first place.

The 401(k)’s Tax Incentives Are ‘Upside Down’

One of the comments you hear from time to time is that the tax incentives for 401(k)s are “upside down” (or as it has been more colorfully described, “out of whack”) — that is, they go primarily to those at higher income levels, who perhaps don’t need the encouragement to save. And from a pure financial economics perspective, those who pay taxes at higher rates might reasonably be seen as receiving a greater benefit from the deferral of those taxes.

Indeed, if those “upside-down incentives” were the only forces at work, one might reasonably expect to find that the higher the individual’s salary, the higher the overall account balance would be, as a multiple of salary. However, drawing on the actual administrative data from the massive EBRI/ICI 401(k) database, and specifically focusing on workers in their 60s (broken down by tenure and salary), EBRI Research Director Jack VanDerhei has found that those ratios hold relatively steady. In fact, those ratios are relatively flat for salaries between $30,000 and $100,000, before dropping substantially for those with salaries in excess of $100,000.

In other words, while higher-income individuals have higher account balances, those balances are in rough proportion to their incomes. They are not “upside down.” Now this is the outcome — the balances — not just focused on the contributions, the amount(s) going in, which is what most of the criticism focuses on.

As retirement plan advisors are well aware, these programs are subject to a series of limits and nondiscrimination test requirements: the boundaries established by Code Sections 402(g) and 415(c), combined with the ADP and ACP nondiscrimination tests. Those plan constraints were, of course, specifically designed (and refined) over time to maintain a certain parity between highly compensated and non-highly compensated workers in the benefits available from these programs. The data suggest they are having exactly that impact.

More recently, the “fairness” of these incentives has been questioned since they “only” go to workers who are covered by workplace retirement plans (though, as I pointed out last week, those numbers are often distorted as well). A better solution might be to expand those covered by such plans, rather than to undermine the diligence of those who are saving.

You’re less likely to hear these statements in your earshot — they tend to show up in academic forums, and sometimes in legislative hearings — forums where “decorum” might suggest avoiding confrontation.

But this is not just an academic exercise. And no one is well served — even the often well meaning academics who are trying to help improve the current system — by perpetuating misunderstandings.

- Nevin E. Adams, JD

The Impact of Assumptions on the Impact of Leakage

It has become something of an article of faith in our industry that “leakage,” the distribution of money from retirement accounts prior to retirement, is bad.

Bad, of course, in the sense that those “premature” withdrawals, via hardship withdrawals, loans or the so-called “deemed distributions” that result when a termination occurs when a loan is outstanding, reduce individual retirement savings.

So when the Center for Retirement Research at Boston College published a paper last week entitled “The Impact of Leakages on 401(k)/IRA Assets,” it really wasn’t a question of “if” there was an impact, it was a question of how much. The answer, according to the paper: a reduction in wealth at retirement of a jaw-dropping 25%.

Now by any measure, a 25% reduction in retirement wealth is a massive problem — and one that would, if valid, call for the kind of countermeasures touted by the Boston College researchers.

But consider the findings published recently by the non-partisan Employee Benefit Research Institute (EBRI) based on its massive participant database of actual participant balances and activity. Among participants with outstanding 401(k) loans at the end of 2013, the average unpaid balance was a mere $7,421, and the median loan balance outstanding was $3,973.

Moreover, the report notes — as it has for a number of years examining trend analysis in that database — that overall, loans from 401(k) plans tended to be small, with a sizable majority of 401(k) participants in all age groups having no loan outstanding at all: 88% of participants in their 20s, 73% of participants in their 40s, and 86% of participants in their 60s had no loans outstanding at year-end 2013.

So, how did the Boston College researchers manage to come up with a 25% reduction in retirement wealth? Quite simply, they started by deriving an estimate based on a “host of simplifying assumptions” — their words, not mine.

What are those simplifying assumptions? It starts with a hypothetical participant who initially makes $40,000/year, gets a 1.1% annual pay increase in real terms, assumes that he/she defers 6% of pay, is matched at a rate of 50 cents on the dollar, and whose investments gain a 4.5% real annual return. But the key assumption — and the one that arguably creates the conclusion of the paper — is their further assumption that 1.5% of assets leak out each year!

Under these assumptions, the leakages result in accumulated 401(k) wealth of $203,000 at age 60 compared with $272,000 with no leakage. So their math (and assumptions) lead to a conclusion that these leakages reduce 401(k) wealth by 25%. To “prove” the point, they provide a simple chart of the numbers they just produced, and direct the reader to it as though it provides some sort of independent corroboration.

They go on to clarify: “This estimate represents the overall impact for the whole population, averaged across both those who tap their savings before retirement and those who do not.” That’s right — averaged across everyone, not just those who actually dip into those savings prior to retirement.

Now at that point, it’s arguably just math, not so much a quantification of the impact of leakages as the mathematical impact of a series of simplifying assumptions. As for the so-called impact of leakages? It might more accurately be described as the impact of assumptions.

- Nevin E. Adams, JD

That’s not to say that leakages don’t have an impact on retirement accumulations, and doubtless for some, that impact is significant. EBRI’s analysis found that among loan defaults, hardships and cashouts at job change, cashouts were found to have a much more serious impact on 401(k) accumulation than either plan loan defaults or hardship withdrawals (even with the impact of a six-month suspension of contributions included). The leakages from cashouts resulted in a decrease in the probability of reaching an 80% real replacement rate of 5.9 percentage points for the lowest-income quartile and 4.5 percentage points for those in the highest-income quartile. In fact, the effect from cashouts (by themselves) — not loans or hardship withdrawals — turns out to be approximately two-thirds of the leakage impact.  

It’s also worth noting that it’s one thing to quantify the impact of not allowing early access to these funds — and something else altogether to assume that participants and plan sponsors would not respond in any way to those changes, perhaps by reducing their contribution levels, or by either deciding to continue to participate or to participate in the first place.

"Out" Takes

My first car wasn’t anything special, other than it was my first car. It was an older model Ford, ran reasonably well, with one small problem— it went through oil almost as quickly as it did gasoline. At first I attributed that to being a function of the car’s age, but as the leakage grew, I eventually dealt with it by keeping a couple of quarts of oil in the trunk “just in case.” Eventually, I took the car to a dealership—but by the time they finished estimating the cost of a head gasket repair, let’s just say that, even on my limited budget, I could buy a LOT of oil by the quart, over a long period of time, and still be ahead financially.

“Leakage”—the withdrawal of retirement savings via loan or distribution prior to retirement— is a matter of ongoing discussion among employers, regulators, and policy makers alike. In fact, EBRI Research Director Jack VanDerhei was recently asked to present findings on “The Impact of Leakages on 401(k) Accumulations at Retirement Age” to the ERISA Advisory Council in Washington.[1]

EBRI’s analysis considered the impact on young employees with more than 30 years of 401(k) eligibility by age 65 if cashouts at job turnover, hardship withdrawals (and the accompanying six-month suspension of contributions) and plan loan defaults were substantially reduced or eliminated. The analysis assumed automatic enrollment and (as explicitly noted) no behavioral response on the part of participants or plan sponsors if that access to plan balances was eliminated.

Looked at together, EBRI found that there was a decrease in the probability of reaching an 80 percent real income replacement rate (combining 401(k) accumulations and Social Security benefits) of 8.8 percentage points for the lowest-income quartile and 7.0 percentage points for those in the highest-income quartile. Said another way, 27.3 percent of those in the lowest-income quartile (and 15.2 percent of those in the highest-income quartile) who would have come up short of an 80 percent real replacement rate under current assumptions WOULD reach that level if no leakages are assumed.

The EBRI analysis also looked at the impact of the various types of “leakage” individually. Of loan defaults, hardships, and cashouts at job change, cashouts at job change were found to have a much more serious impact on 401(k) accumulation than either plan loan defaults or hardship withdrawals (even with the impact of a six-month suspension of contributions included). The leakages from cashouts resulted in a decrease in the probability of reaching an 80 percent real replacement rate of 5.9 percentage points for the lowest-income quartile and 4.5 percentage points for those in the highest-income quartile. That effect from cashouts—not loans or hardship withdrawals—turns out to be approximately two-thirds of the leakage impact.

However, and as the testimony makes clear, it’s one thing to quantify the impact of not allowing early access to these funds—and something else altogether to assume that participants and plan sponsors would not respond in any way to those changes, perhaps by reducing contributions,[2] potentially offsetting some or all of the prospective gains from restricting access to those funds.

Because ultimately, whether you’re dealing with an old car or your retirement savings account, what matters isn’t how much “leaks” out—it’s how much you put in, and how much you have to “run” on.

Nevin E. Adams, JD

[1] EBRI’s testimony for the ERISA Advisory Council, U.S. Department of Labor Hearing on Lifetime Participation in plans is available online here.  

[2] An EBRI/ICI analysis published in the October 2001 EBRI Issue Brief found that, “[o]n average, a participant in a plan offering loans appeared to contribute 0.6 percentage point more of his or her salary to the plan than a participant in a plan with no loan provision.” Testimony provided to the ERISA Advisory Council testimony notes that it’s likely that a similar relationship exists with respect to the availability of hardship withdrawals. See “Contribution Behavior of 401(k) Plan Participants,” online here.

A Year-End "Review"

This is the time of year when many people both look back at the year just past—and ahead to the next with a fresh perspective. It’s also that time of year when many make lists.

So, whether you’re looking to make some New Year’s resolutions, or just looking to improve your overall financial situation, here are 10 things to check off your 2013 list—and that can get your 2014 list off to a strong start.

1. Deal with debt (see Savings Resolutions for the New Year).
2. Establish a savings goal for retirement (see Estimate “Ed”).
3. Save for retirement—at work, or on your own (see Saving for Retirement Outside of Work).
4. Save early so that your savings can work for you (see The “Magic” of Compounding).
   
5. If you do have a retirement plan at work, make the most of it (see Making the Most of your Retirement Plan).
6. Maximize your savings—see if you’re eligible for the Savers’ Credit (see Credit Where Credit is Due).
7. See if a Roth 401(k) makes sense for your situation (see To Roth or Not?).
8. Know how much you’re paying for your retirement savings (see Shedding Some Light on your Workplace Retirement Plan Fees).
9. Keep an eye on your retirement savings investments (see Are Your Savings Investments Over-weighted?).
10. Don’t forget that you may have other important savings goals as well (see College “Education”–Saving For College).

Of course, a good place to start—any time—is to Choose to Save.^® You can find a wide variety of tools and resources—including the popular and widely recommended BallparkE$timate—at www.choosetosave.org[1]


Nevin E. Adams, JD

---

If you are interested in, or working on, issues of financial literacy or savings education, you’ll want to check out $avings Account$, a free monthly update from the American Savings Education Council (ASEC) on the latest research and updates on new (and old but relevant) tools, as well as keep you up-to-date on various events, conferences, and symposiums relevant to ASEC’s Mission: To make saving and retirement planning a priority for all Americans.  You can sign up online here.

[1] Organizations interested in building/reinforcing a workplace savings campaign can also find a variety of free resources there, courtesy of ASEC.  Choose to Save® is sponsored by the nonprofit, nonpartisan Employee Benefit Research Institute Education and Research Fund (EBRI-ERF) and one of its programs, the American Savings Education Council (ASEC). The website and materials development have been underwritten through generous grants and additional support from EBRI Members and ASEC Partner institutions.

Take It or Leave It?

While each situation is different, in my experience leaving a job brings with it nearly as much paperwork as joining a new employer. Granted, you’re not asked to wade through a kit of enrollment materials, and the number of options are generally fewer, but you do have to make certain benefits-related decisions, including the determination of what to do with your retirement plan distribution(s).

Unfortunately, even in the most amicable of partings, workers have traditionally lacked the particulars to facilitate a rollover to either an individual retirement account (IRA) or a subsequent employer’s retirement plan—and thus, the easiest thing to do was simply to request that distribution be paid to him or her in cash.

Over the years, a number of changes have been made to discourage the “leakage” of retirement savings at job change: Legal thresholds for mandatory distributions have been set; a requirement established that distributions between $1,000 and $5,000 on which instructions are not received either be rolled over into an IRA or left in the plan; and even the requirement that a 20 percent tax withholding would be applied to an eligible rollover distribution—unless the recipient elected to have the distribution paid in a direct rollover to an eligible retirement plan, including an IRA. All these have doubtless served to at least give pause to that individual distribution “calculus” at job change.

Indeed, a recent EBRI analysis¹ indicates that workers now taking a retirement plan distribution are doing a better job at holding on to those retirement savings than had those in the past. Among those who reported in 2012 ever having received a distribution, 48.1 percent reported rolling over at least some of their most recent distribution into another tax-qualified savings vehicle, and among those who received their most recent distribution through 2012, the percentage who used any portion of it for consumption was also lower, at 15.7 percent (compared with 25.2 percent of those whose most recent distribution was received through 2003, and 38.3 percent through 1993).

As you might expect with the struggling economy, there was an uptick in the percentage of recipients through 2012 who used their lump sum for debts, business, and home expenses, and a decrease in the percentage saving in nontax-qualified vehicles relative to distributions through 2006. However, the EBRI analysis found that the percentage of lump-sum recipients who used the entire amount of their most recent distribution for tax-qualified savings has increased sharply since 1993: Well over 4 in 10 (45.2 percent) of those who received their most recent distribution through 2012 did so, compared with 19.3 percent of those who received their most recent distribution through 1993.

The EBRI report also notes that an important factor in the change in the relative percentages between the 1993 and 2012 data is the percentage of lump sums that were used for a single purpose. Consider that among those who received their most recent distribution through 2012, nearly all (94.0 percent) of those who rolled over at least some² of their most recent distribution did so for the entire amount.

There is both encouraging and disappointing news in the EBRI report findings: The data show that improvement has been made in the percentage of employment-based retirement plan participants rolling over all of their LSDs on job change, along with less frequent pure-consumption use of any of the distributions. However, the data also show that approximately 55 percent of those who took a lump-sum payment did not roll all of it into tax-qualified savings.

In common parlance, “Take it or leave it” is an ultimatum—an “either/or” proposition that frequently comes at the end, not the beginning, of a decision process. However, as the EBRI analysis indicates, for retirement plan participants it is a decision that can (certainly for younger workers, or those with significant balances) have a dramatic impact on their financial futures.

Nevin E. Adams, JD

 

¹ The November 2013 EBRI Notes article, “Lump-Sum Distributions at Job Change, Distributions Through 2012,” is online here. 

 

² Two important factors in whether a lump-sum distribution is used exclusively for tax-qualified savings appear to be the age of the recipient and the size of the distribution. The likelihood of the distribution being rolled over entirely to tax-qualified savings increased with the age of the recipient at the time of receipt until age 64. Similarly, the larger the distribution, the more likely it was kept entirely in tax-qualified savings.

“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.