By Nancy Hwa
In an earlier blog post, we discussed efforts in Congress to make it easier for people to withdraw money from their 401(k) accounts to save their homes from foreclosure. Such withdrawals are part of a larger problem with 401(k)s known as “leakage” (what a lovely name!) – loans, early withdrawals, and lump-sum payouts that reduce or deplete a worker’s retirement savings account long before the worker actually retires. Between withdrawal penalties, interest charged on loans, and the overall reduction in their retirement savings, “leakage” has long-term consequences that many workers aren’t aware of until it’s too late.
On Wednesday, the Special Committee on Aging of the U.S. Senate held a hearing on the impact of 401(k) loans and withdrawals. A fundamental point that we made in our statement to the committee is the fact that 401(k) plans were intended to be a supplement to retirement income, not the primary source of it:
There was a time when most large and medium-sized American businesses sponsored real pension plans, which provided employees with a guaranteed lifetime benefit when they retired. In such plans, employees could not withdraw benefits before they retired and plan loan programs were virtually non-existent.
In this universe, defined contribution plans – such as today’s 401(k) plans – were usually supplemental retirement plans, the savings leg on the proverbial three-legged stool of retirement preparation. It thus made some sense for our legal rules to permit employers to provide some pre-retirement access to account balances through loans and in-service withdrawals, since many employees were not dependent on these plans for the majority of their retirement income. Moreover, as 401(k) plans increasingly came onto the scene, advocates for withdrawals argued forcefully that employees would be reluctant to contribute to such plans unless they had some emergency access to their money.
But the landscape of retirement savings has undergone seismic change during the last two decades. In 1983, 63 percent of private sector workers had defined benefit plans and 12 percent had defined contribution plans. In 2004, this was totally reversed: 63% had defined contribution plans (primarily 401(k) plans) and only 20 percent had defined benefit plans. What this means is that for millions of people, their 401(k) plan accumulations will be their only source of retirement income other than Social Security.
Witnesses at the hearing included Christian Weller of the Center for American Progress, who is co-author of a new study on 401(k) loans. Looking at 15 years of data on 401(k) loans, the authors conclude that solutions must be found to reduce people’s need or desire to tap into their 401(k)s.
The hearing got quite lively when it came to the subject of 401(k) debit cards. Imagine being able to take money out of your 401(k) account with just a swipe of a card. It’s fast! It’s easy! It’s the dumbest idea since New Coke! Anyone with a regular debit card or a credit card knows how much easier it is to spend money with a little piece of plastic. Credit card debt is a serious issue in this country. Borrowing from your 401(k) only compounds the problem. Fortunately, Senator Herb Kohl (D-WI) and Senator Chuck Schumer (D-NY) are introducing legislation to stop this harebrained scheme.