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Rich and Co.

A Fair, Balanced and Fact-Based Perspective on 401k Loans — At Last

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Have to say Jack is about the only fact-based, expert, experienced and balanced voice we have heard on these topics in the (social) media. The popular media and social media are, regrettably and inaccurately, dominated by the “loudest voices” of the anti-401k interests and 401k “haters.”

Unfortunately, fact-based and free and fair points of view do not “sell newspapers” or get “eyeballs” so are ignored. Human nature.

Below is a recent comment on a Linked In blog post on a WSJ article.  It’s printed in full.

Jack Towarnicky • I sent this to Mr. Zweig. Sorry if this is a duplicate.

Thank you for your very fine article on loans from 401(k) plans (June 25/26, 2011, “Banking on Yourself: Is it Ever OK to Raid Your 401(k)?”

When I read the word “raid” in the headline, I had fears it would be just one more unbalanced attack on 401(k) loans. However, the article was very balanced and insightful for WSJ readers and confirmed that thoughtful, intelligent use of a 401(k) loan is not a “raid” on your retirement preparation..

One item missing from your article is context – who is saving, and how participants access money from their 401(k). First, most Americans are not saving for retirement. Simply, professional studies have shown that access to loans from 401(k) accounts, used properly, actually increases participation and improves a worker’s personal financial situation. We need to take action as necessary in order to encourage workers to save more than they think they can afford to earmark for retirement. Second, importantly, a 401(k) participant generally has two choices when she decides to access money from a 401(k) prior to retirement – a loan or a withdrawal (hardship in-service and/or post-separation). Our goal should be to ensure that loans are structured to be considerably more attractive than withdrawals.

We have a great opportunity here, as highlighted in a 2009 General Accountability Office report, GAO 09-715, Policy Changes Could Reduce the Long-term Effects of Leakage on Workers Retirement: http://www.gao.gov/new.items/d09715.pdf

There, GAO found considerable leakage in 2006 from what was then a $2.7T asset base – $74B of cashout at job change (88.6% of leakage), $9B of hardship withdrawals (10.8% of leakage), and $561MM of loan defaults (.67% of leakage). As you can see, leakage from loans was less than 1% of total leakage – because most loans are paid prior to separation.

Today, unlike any time in the past, we have the tools to ensure a 401(k) loan is substantially more efficient and, more importantly, substantially more likely to be repaid and substantially less likely to become leakage. In one of my 401(k) plans, not only did the plan sponsor eliminate hardship withdrawals from the 401(k) way, way back in 1996, but they also added a formal, electronic bill paying process so those who separate can efficiently continue loan payments. In fact, the plan allows workers to initiate a loan after separation using an electronic banking process. This option is substantially better than a taxable withdrawal – such as for a 45 year old who changed jobs, and who always planned to use a 401(k) loan to finance college education for her daughter.

A 2010 study by the Pension Research Council show that loans are almost always repaid while employment continues. A 2010 study by Russell Voth, then at the University of California, Berkeley, confirmed that loan access generally provided a net improvement in financial status of participants. Similar results were achieved by Geng Li and Paul Smith, of the Federal Reserve in 2008 who concluded: “… we estimate that such households could have saved as much as $5 billion in 2007 by shifting expensive consumer debt to 401(k) loans….”

No one should take 401(k) loans lightly. But, policymakers do a disservice to Americans when they lump loans in with withdrawals and talk about them as leakage equivalents. Loans that are repaid are not leakage.

For today’s worker, many of whom live paycheck to paycheck, an optimum result might look like: workers who save when first eligible, receive available company match, invest, build an account, borrow to meet a short term need, repay the loan while continuing contributions, rebuilding the account to meet a future, greater need. Save, match, invest, borrow, continue contributions, repay the loan, rebuild the account; build the “Bank of

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Written by Rich and Co.

June 26, 2011 at 8:22 pm

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