A new bill aims to make it more difficult for workers to take out 401(k) loans, but easier to pay them back. Senators Herb Kohl, a Wisconsin Democrat, and Mike Enzi, a Wyoming Republican, introduced a bill on Wednesday with provisions intended to prevent the leakage of savings from 401(k)s before retirement.
Reduce early access. The Savings Enhancement by Alleviating Leakage in 401(k) Savings Act of 2011, or SEAL Act, reduces the number of loans that 401(k) participants can take to three at a time. Currently employers determine the number of loans available. “While having access to a loan in an emergency is an important feature for many participants, a 401(k) savings account should not be used as a piggy bank,” says Kohl . “As the frequency of retirement fund loans have gone up, the amount of money people are saving for their retirement has gone down.” The legislation also bans products that actively encourage 401(k) participants to tap into their savings before retirement, such as a debit card linked to a 401(k) account.
This legislation wouldn’t prevent most 401(k) participants from accessing their money. The typical individual with a 401(k) loan had only one (69 percent) or two (29 percent) loans outstanding in 2010, according to an Aon Hewitt analysis of 110 large 401(k) plans with 1.8 million employees released this week. Only 2.5 percent of people who borrowed from their retirement account last year had more than two loans simultaneously.
Longer loan repayment period. Repayment of 401(k) loans would get easier under the new legislation. Employees with 401(k) loans who lose their jobs generally must repay the entire outstanding balance of the loan within 60 days of job termination. Any amount not repaid is considered a 401(k) withdrawal and the account holder incurs tax penalties and, if under age 59½, a 10 percent early withdrawal penalty. Nearly 70 percent of employees with 401(k) loans who lose their jobs default on the repayment and must pay the penalties, compared to 3 percent of continuously employed individuals who default on their loans, Aon Hewitt found.
The SEAL Act would give employees until their tax deadline that year to contribute the outstanding loan balance to an IRA before income tax and the early withdrawal penalty would be applied to the loan balance. “Our bill would allow for a greater period of time for the loan to be paid back, thereby helping families pay back the loan and allowing the funds to be put back into their retirement savings,” says Enzi.
Eliminate contribution restrictions. The bill would also allow 401(k) participants to continue to make contributions during the 6 months following a hardship withdrawal. Employees are currently prohibited from contributing to a 401(k) for 6 months after a 401(k) hardship withdrawal, which causes workers to miss out on any 401(k) match offered and discourages continued saving for retirement. Hardship withdrawals, which were for an average of $5,510 in 2010, are most often taken to avoid a home eviction or foreclosure or to pay for medical or education expenses.
401(k) loans are common among retirement savers, especially among individuals in their 40s and those earning between $40,000 and $60,000 annually. Approximately 28 percent of 401(k) participants had an outstanding loan in 2010, up from 22 percent in 2005, Aon Hewitt found. The average loan was $7,860, which represented 21 percent of these participants' total retirement assets. Most 401(k) participants with a loan continue to save in the 401(k) plan (82 percent), but their average savings rate (6.2 percent of pay) is lower than those who do not have a loan outstanding (8.1 percent of pay).