The 401(k) Loan Has Grown

By Patty Kujawa

Nov. 25, 2014

Gary Davis wears a lot of hats. He is the mayor of Elk Grove, California, director of board engagement and leadership development at the California Charter Schools Association and has recently added “entrepreneur” to the list with the two coffee shops he has opened in the area over the past year.

To open Grace Coffee Roasters’ first location Davis sold some of his stocks, but he also pulled $25,000 out of his then-$200,000 401(k) account to start up the second.

“We hadn’t been around long enough to get conventional financing,” for the second location, Davis said. “There is risk involved, but I’m confident I’ll pay it off.”

Loans from 401(k) plans should be used as a last resort, said Meghan Murphy, director of thought leadership for Fidelity Investments. But more participants are borrowing larger amounts from their 401(k) plans, an October study from Fidelity showed.

“The loans being taken today are much bigger than the ones taken even a few years ago,” Murphy says. “This can have a huge impact in the long run.”

Among Fidelity’s 9 million active participants, nearly 1 million took loans, with the average loan at about $9,500 over the past year. Two years ago, about 850,000 people took loans averaging about $9,000.

Fidelity also found that from June 2013 to June 2014, 27,000 people took an average $23,500 loan from their 401(k) to buy a home. Millennials borrowed on average $17,100, or 37 percent of their balance, for a home, while Gen Xers took $25,600, or 26 percent, out of their accounts. Baby boomers pulled$28,000, or 17 percent, for a home loan.

Murphy said participants need to make sure they can keep contributing to their 401(k) plan when borrowing money because it can significantly reduce overall retirement savings. Fidelity data show 40 percent of borrowers reduce their savings rate within five years of taking a loan. When that happens, people can miss out on $180 to $690 a month in retirement.

“A lot of loan takers aren’t good savers to begin with, and reducing contributions is a big concern,” Murphy said.

Plan design can have a lot to do with participants eyeing the cash they’ve stocked away for retirement, Murphy said. Companies aren’t required to offer loans, but data from the Plan Sponsor Council of America show that nearly 88 percent of 401(k) plans offered loans in 2012, the latest data available.

By law, participants who are able to borrow can take the lesser of $50,000 or half of their account balance. Workers who leave their company before paying off the 401(k) loan must pay it back in full or face stiff fines.

Plan sponsors have some flexibility in structuring loans, Murphy said. Some of these strategies include limiting the number of loans participants can take simultaneously; wait periods between paying off a loan and getting a new one; setting a high interest rate, which is usually targeted to 1 or 2 percent above the prime rate; setting minimum loan amount; and payback schedule.

Most companies, like Preferred Family Healthcare in Kirksville, Missouri, offer loans as a way to get workers to participate in plans. People feel more comfortable with saving if they know they can access their accounts if they need to, said Stacey Hudson, plan administrator for the health care company’s $5.5 million 401(k) plan.

Right now, Preferred Family Healthcare has 43 loans outstanding, ranging from $1,000 to $25,000 with a total of $250,000 borrowed overall. Workers can only take out one loan at a time, and must wait a year after they’ve paid off a loan to take out a new one. If they decrease their 401(k) savings rate while paying back a loan, participants receive education materials showing how this affects overall savings. Workers who pay off a loan are also given information on how to increase contributions.

Preferred Family Healthcare charges whatever the prime interest rate is on each loan. Like most 401(k) loan structures, borrowers get that money back into their accounts when they pay it off.

Hudson said she has seen more workers borrow money as their accounts grow and interest rates stay low. She added that she isn’t worried about workers taking loans because Preferred Family Healthcare offers education, and extraordinarily large amounts aren’t taken out.

“We think this is a good way for workers to borrow their own money,” Hudson said. “A lot of these loans are for medical bills, and [workers] would rather do this than take a [paycheck] garnishment.”

Patty Kujawa is a freelance writer based in Milwaukee.

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