Participants acting responsibly with CARES Act loan provisions

The CARES Act presented defined contribution participants and retirement executives with a challenge: Would the rules for loans and distributions — more liberal than traditional policies — interrupt long-term savings strategies as participants used the law to meet emergency needs caused by the coronavirus?

"Clearly, that could be one of the unintended consequences," said Joshua Dietch, vice president of retirement thought leadership for T. Rowe Price Group Inc., Baltimore, about the prospect of participants losing long-term savings momentum by taking CARES Act loans and/or distributions.

"That was one of the emotions when the act came out," added David Stinnett, the Malvern, Pa.-based principal and head of the Vanguard Strategic Retirement Consulting Group. "The next impulse in the industry was, 'I hope they don't overuse this.'"

For the most part, they haven't.

More than five months after the law's passage, surveys and record-keeping data show that, in general, participants' use of the law's loan and distributions provisions so far has ranged from meager to modest.

Record keepers suggest that design changes have softened the blow of coronavirus-induced leakage and could help participants regain the momentum of long-term savings.

Before participants could take advantage of the CARES Act provisions, their plan sponsor had to opt in, with early research offering mixed results. Among clients of Vanguard Group Inc., for example, 65% as of May 31 said they wanted to offer CARES Act features. A survey of 840 plan sponsors conducted in mid-May to early June by the Secure Retirement Institute found that 38% didn't offer loans or distributions authorized by the law and 19% said were unsure if they would.

The Coronavirus Aid, Relief, and Economic Security Act was signed into law by President Donald Trump on March 27. Soon afterward, Jack VanDerhei, research director of the Employee Benefits Research Institute, Washington, began working on economic models to assess how the CARES Act might affect the "future retirement security" of workers.

"I don't think it's going to be drastic for the majority" of DC plan participants, Mr. VanDerhei said, referring to the CARES Act's impact on long-term savings. "Some people will have serious consequences."

He prepared scenarios and issued them in a July 30 report."We see potentially significant reductions in retirement benefits" when employees take the maximum — $100,000 — distribution under the CARES Act and don't pay it back, the report said. "This is especially true for older age cohorts."

His models estimated at the median that overall participants taking a $100,000 distribution and not repaying that amount would suffer a 20% decline in retirement balances at age 65, the report said. If they took out the full amount but paid it back in three years, the balances would fall by 2.3%.

However, in a preliminary analysis of his models, applied to an actual survey of plan sponsors, he concluded that "reductions were very small," the report said. Even if employees didn't pay back the distribution, the estimated cut in account balances was less than 0.5%, said the report, attributing the findings to "low estimated implementation and utilization" of CARES Act provisions.

Mr. VanDerhei said in an interview his early modeling had to deal with "big uncertainties" — how many sponsors would offer one or more of the act's provisions, how many record keepers would participate, and how effective would be the communication to participants about balancing short-term needs against long-term savings.

Another hard-to-measure factor is how many people will lose their jobs. "Unemployment is the crucial issue," he said.

Remarking that the CARES Act's impact on retirement savings has "50 different moving parts," he added that "there's more uncertainty here than with anything I have done before."

Mr. VanDerhei is preparing new models based on more recent data from multiple record keepers. "I suspect I will have everything I need some time this fall," he said.

Mr. VanDerhei's preliminary analysis used data from a survey published in June by the Plan Sponsor Council of America, Arlington, Va., covering 137 sponsors.

The survey said 18.4% of plans reported no participants taking a coronavirus-related distribution when permitted. For 34.5% of plans, less than 1% of participants took a distribution. For 37.9% of plans, only 1% to 5% of participants took a distribution.

Aggregate percentages don't necessarily tell the whole story, said Will Hansen, executive director of PSCA, because certain industries and their employees — retail, travel, restaurants, small businesses — were hit harder than most.

The rate of participants taking CARES Act loans was equally modest, the PSCA survey said. Twenty-six percent of plans reported no loans; 52% of plans reported less than 1% of participants taking loans; and 16% of plans said 1% to 5% of participants took loans.

"In the end, the CARES provisions will assist people with dire needs," Mr. Hansen said. The law will "add to the conversation" about establishing more ways to provide for emergency savings outside of the retirement system, he said. "That's a role for Congress to play to incentivize employers and employees."

Data from large record keepers illustrate similar results over a broader population than was covered by PSCA.

During the second quarter, for example, Fidelity Investments, Boston, reported that 7% of participants in its record-kept plans took distributions, and the CARES Act accounted for 38% of that amount.

Total distributions for the second quarter was "only slightly higher" than for the second quarter of 2019, according to the report, which analyzed actions of 25.3 million participants. Meanwhile, Fidelity found that during the second quarter, 18.9% of participants had outstanding loans compared with 20.6% in the second quarter of 2018. Because sponsors have favored adopting the CARES Act distribution provisions over loans, "many participants opted for this instead of a traditional loan," the report said.

Among clients of T. Rowe Price, only 6% of participants had taken a coronavirus-related loan or distribution or suspended loan repayments between early March and the end of July, even though two-thirds of clients offered at least one CARES Act provision. The firm's analysis, published last month, covered 2.2 million participants.

This response contrasted to a 2018 study in which T. Rowe Price asked participants if they took a hardship withdrawal or loan during the 2008-2009 economic crisis. Nineteen percent said they did even though they knew they would pay a penalty on the withdrawal and incur an immediate tax liability.

The more muted participant response during the current crisis could be due to several factors that make "today's participant a better saver," Mr. Dietch said. He cited improved education about retirement, sponsors' and record keepers' better understanding of consumer behavior and plans' greater emphasis on financial wellness.

These efforts have been augmented by plan-design changes such as auto features and qualified default investment alternatives, he said.

Mr. Dietch said he was encouraged by participants' savings behavior as only 2.5% of participants stopped making salary deferrals and 5.6% reduced savings rates through July.

However, he worried that some participants "might be undoing years of savings." Although the overall percentage of participants taking coronavirus-related distributions is low, 21% of those participants withdrew the maximum — the lesser of 100% of the vested account balance or $100,000, he said.

Average loan amounts were three times higher for participants taking CARES Act loans than other plan loans, he added.

Vanguard Group's record-keeping data showed that only 4% of participants took a coronavirus-related distribution for the first eight months of this year, according to the latest research.

Twenty-six percent took less than $5,000 while 37% took between $5,000 and $19,999, according to research based on records from 1,142 plans with 4.2 million participants.

However, for 35% of all participants taking this distribution, the amount represented 90% or more of their account balance. Those with CARES distributions accounting for a higher portion of their account balances tended to be younger and have lower balances, less tenure and less income than others taking distributions, said Vanguard's Mr. Stinnett.

"What surprised me was that for a very broad piece of legislation how narrowly tailored the utilization has been," he said.

For those who took distributions, Vanguard prepared a model that shows "typical" participants — based on median amounts — could make up the shortfall over time "by simply increasing their deferral rate by 1 percentage point."

DC plans could help these participants through enhanced auto features and re-enrolling undersavers at higher contribution rates. "It's a relatively modest, relatively painless way to close the gap," he said.