Number of people taking 401(k) loans hitting record high

Jar full of coins

The number of people using their retirement accounts as a source of spare cash is increasing. Photo Credit: godfreja/Flickr.com/CC-BY

The number of people taking loans from their 401(k) accounts is reaching record highs. More people are resorting to taking money from their retirement accounts, which many advisers would say is not a sound financial move. Some members of Congress are trying to limit the number of times a person can borrow from their retirement funds.

Retirement accounts being raided

AON Hewitt, the human resources company of the AON Corporation, noted in 2010 that one in seven, or about 14 percent, of people who had a 401(k) managed by AON Hewitt had borrowed from their retirement account, according to SmartMoney. That was a 14 percent increase from 2009. During 2010, investment houses T. Rowe Price and Vanguard both noticed an 11 and 14 percent increase in 401(k) loans, respectively. It is thought that up to 28 percent of all people holding a 401(k) account have taken a personal loan from their own retirement account at some point. It is estimated that up to 30 million people may borrow from their retirement accounts by 2014, according to CBS.

Congress seeking to cap borrowing

In May of this year, Congress announced that it would be introducing a bill that would limit the number of times that a person could borrow from their 401(k). Senator Herbert Kohl, a Democrat from Wisconsin and namesake of the Kohl’s department store chain and the chairman of the Senate Special Committee on Aging, sponsored a bill called the Savings Enhancement by Alleviating Leakage in 401(k) Savings Act. It was co-sponsored, according to Business Week, by Mike Enzi, a Wyoming Republican. The bill would limit the number of loans a person could borrow to three per person over their lifetime. Currently, there is no limit, and a person can take a loan against a 401(k) as many times as they want to, or are permitted to by their employer or plan administrator. The bill, according to Govtrack, was referred to the Senate Finance Committee in mid-May and hasn’t gone anywhere since.

Advantages to borrowing

Taking an installment loan from one’s 401(k) has some advantages and disadvantages. First, any interest or appreciation that the funds would have made while the loan is being repaid is lost. However, the interest rate on the loan itself may make up for any lost interest. If an account is only gaining 3 percent but the interest rate on a 401(k) loan is 6 percent, the borrower technically has doubled their gains for the amount of money that was borrowed. If the loan, according to SmartMoney, is used to pay off high interest debt, that is also a net benefit; essentially, a high interest debt has been replaced with a low one. Also, the thing about borrowing from a retirement account is that one pays ones’ self back, not a bank. That said, if one loses their ability to repay, or defaults on the loan, then retirement funds have been lost. Furthermore, the Internal Revenue Service imposes a 10 percent tax on early 401(k) withdrawals.

Sources

SmartMoney

CBS

Business Week

GovTrack

Internal Revenue Service

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