The Plan Sponsor Council of America's 61st annual survey showed 30.6% of participants had a plan loan as of the end of 2017 — up 5 percentage points from a year earlier. The average loan outstanding was $9,330, 1.2% of plan assets.
Most benefits professionals would say this is cause for alarm. Ten years earlier, only 24.1% had loans, averaging $8,309, 2.8% of plan assets. So, while the percentage with loans increased, the percentage of plan assets borrowed noticeably declined.
No one should ever borrow from their qualified plan to live beyond their means.
However, firsthand experience confirms participants who take advantage of plan loans rather than the much more expensive alternative of consumer debt often improve their household wealth and retirement asset accumulations.
Surveys, like the American Payroll Association's "Getting Paid in America," show 71% of Americans live paycheck to paycheck — a one-week delay in the next paycheck would cause some or significant financial difficulty. The Federal Reserve's report on the "Economic Well-Being of U.S. Households" confirms 41% of adults do not have $400 to pay an emergency expense. The National Foundation for Credit Counseling reports that 38% of households carry a credit card balance. The Federal Reserve reported that revolving debt (mostly credit cards) was $1.027 trillion — $5,839 per adult with a credit card, with an average interest rate of 16%, and where 28% of payments were missed or delayed. The Center for Financial Services Innovation reports approximately 12 million Americans take payday loans each year, averaging $375 at a 400% interest rate and average cost of $520.
Department of Labor and IRS regulations require a reasonable rate of interest. Today, plan loans typically charge 1% to 2% above prime; most plans charge between 5% and 6%. Consider the aggregate annual return for the past six years for the Bloomberg Barclays U.S. Aggregate Bond index: -2.02% (2013), 5.97% (2014), 0.55% (2015), 2.65% (2016), 3.54% (2017) and 0.01% (2018).
So, a plan loan at 6% that avoids more than 16% consumer debt will improve household wealth (or reduce debt). And, given recent bond returns, if the participant maintains her investment allocation by treating the plan loan as a fixed-income investment, retirement assets also will increase.
In fact, research by Geng Li and Paul A. Smith of the Federal Reserve confirmed many workers would improve financial wellness by increasing use of plan loans.
Firsthand experience also confirms most participants may improve their household wealth and retirement asset accumulations when they take plan loans instead of hardship withdrawals.
The IRS recently published a notice of proposed rule-making regarding Bipartisan Budget Act of 2008 changes that liberalized hardship withdrawals. In the past, a participant needed to first obtain a plan loan where available. The 2018 legislation removed that requirement and is likely to result in increased leakage starting in 2019.
Workers will complain if you eliminate hardship withdrawal provisions. But, if you concurrently deploy 21st century, best practices loan functionality, retirees may someday thank you.
There are a lot of myths about plan loans, critics assert:
However, perhaps the biggest "myth" about plan loans is that they are harmful to retirement savings. It's true that loans that are defaulted at separation of service can undermine retirement preparation and contribute to leakage, but plan sponsors can avoid evil and harm by:
Jack Towarnicky is the Westerville, Ohio-based executive director of the Plan Sponsor Council of America. This content represents the views of the author. It was submitted and edited under Pensions & Investments guidelines, but is not a product of P&I's editorial team.
