When interest rates WERE falling and housing prices were rising, U.S. consumers happily lived beyond their means using credit cards and home equity loans. Now, with financial markets swooning and the price of everything except houses going up, some Americans may be tempted to turn to their retirement savings, using loans and early withdrawals to pay for their fondest wishes or most pressing needs.
Borrowing against the nation’s estimated $3 trillion in 401(k) assets, however, has not yet shown a significant uptick even as the economy has begun to slow. Vanguard Group, for instance, reports that the percentage of participants taking out loans against the 401(k) assets it manages remained steady in 2007 at 16 percent, the same as the year before. According to the Profit Sharing/401k Council of America, a sponsors’ association based in Chicago, roughly 2 percent of total 401(k) assets were loaned to participants last year, about the same as in 2006. That percentage has hardly budged in the past decade, reports council president David Wray.
Of course, the trend can differ from company to company. Klinger Cos., a Sioux City, Iowa–based commercial and industrial construction company, has 340 participants in its 401(k) plan, which has slightly more than $30 million, according to chief financial officer Robert DeSmidt. He has seen an increase in loans and withdrawals, to 38 in 2007 from 30 in 2006. Recently, as the economic picture has darkened and consumer confidence has slumped, some plan sponsors and administrators also have seen more loans. Merrill Lynch & Co. says borrowing against the 401(k) assets it manages rose 10 percent in May over the same month last year.
And though hardship withdrawals represent a small fraction of total plan assets, the number of such withdrawals has risen significantly in recent months. At T. Rowe Price Group, they were up 22 percent in the first quarter of this year, compared with the same period in 2007. At Merrill Lynch only 0.57 percent of participants took hardship withdrawals in the first half of 2008, but that number represented a 4 percent increase over the same period last year.
“Given the big shock in the housing market and the uptick in hardship withdrawals, there are good odds that the two are linked,” says Stephen Utkus, head of retirement research at Vanguard. The prices of existing homes nationwide declined about 14.1 percent through March 31 from a year earlier, according to Standard & Poor’s Case-Shiller home price indexes.
Almost 90 percent of all 401(k) plans permit participants to withdraw funds from their accounts, and about 85 percent permit loans, according to the Employee Benefit Research Institute, a Washington-based industry group of plan sponsors and administrators.
Most employers allow loans totaling the lesser of $50,000 or 50 percent of an account balance. Interest on such loans is usually prime plus 1 percent and is paid back into the account, not to the manager. The loan repayment period is typically five years. Employees repay loans with automatic salary reductions from their posttax earnings. There are significant penalties if an employee defaults on a loan — or if an employee switches employers before a loan is paid off. In either case, the entire loan amount is due.
As for hardship withdrawals, 401(k) savers can take out their entire vested account balances if they have a medical problem or other emergency that satisfies the requirements of their sponsors. The employee must pay income tax on the sum plus a 10 percent penalty.
Vanguard’s Utkus says plan sponsors and administrators have tended to scold participants for borrowing, perhaps unfairly: “Look at the tone of many commentators — that tapping your 401(k) is somehow economically irrational. When a household is facing enormous economic pressures, it can make sense to tap retirement savings.”
That seems perfectly rational now that other sources of financing are gone. As Robert Boyda, a senior vice president at John Hancock Financial Services in Boston, says: “My neighbor used to work for a large financial institution that has just gone bankrupt, and had refinanced his very comfortable home more than once. I bet my bottom dollar this fellow has emptied his 401(k) account.”
