August 1, 2013

401(k) ‘Leakage’ Is Major Problem: New York Life

Loans against balances are an impediment to retirement success, study finds

“We can’t let people make their own errors,” Vanguard founder John Bogle noted at last year’s Retirement Income Symposium in Boston, when commenting on the effectiveness of 401(k)s. “It’s too expensive.”

Bogle’s view, along with other industry critics, was bolstered on Monday by New York Life Retirement Plan Services’ first “State of the Retirement Industry” report.

It found 401(k) plan participants who take out loans might sabotage their retirement savings. Participants who take loans are more likely to save at a lower contribution rate than their counterparts, and are not likely to repay the loan when leaving their employer.

The average contribution rate for a participant who takes out a loan from their 401(k) is 5.63%, compared with 7.23% for participants without loans, the report said. Additionally, more than two-thirds of participants with an outstanding loan balance who leave their employer will take a cash distribution from their retirement plan rather than paying back the loan. Preventing this so-called "leakage" is very important in helping workers successfully save for retirement, it concludes.

"Americans are not saving enough for retirement and compounding this problem is the fact that loans can drain precious retirement dollars," Rachel Rice, managing director of marketing and product development at New York Life Retirement Plan Services, said in a statement. "As an industry, we need to reverse the ATM mentality that has developed around 401(k) savings by encouraging sponsors to rethink loans from a plan design perspective, and enabling participants to differentiate between every day, emergency and retirement savings."

Loans against 401(k) balances have often been employed as an attempt to increase plan participation and allow participants access to their money during a financial hardship.  While financial hardships exist, New York Life's research indicates that average participation rates for plans without loans are only 9.6 percentage points lower than those plans with loans (67% versus 76%).  While eliminating loans entirely from 401(k) plans may not be practical, the company calls for the number and size of loans available to participants should be limited in scope.

According to the study, the average American worker in a New York Life 401(k) plan is 43 years old, earns $68,700 annually, contributes 6.25% of salary into the 401(k) and has an account balance of $55,270.

Reprints Discuss this story
This is where the comments go.