401(k) borrowing isn’t free
When dire financial need strikes, employees often tap their retirement accounts. While there are cases in which a 401(k) withdrawal makes sense, these loans should be viewed as an absolute last resort.
There are significant downsides related to 401(k) loans such as including penalties, administration and maintenance fees as well as “leakage” from retirement accounts. This occurs when an employee takes a loan on their 401(k), cashes out entirely or leaves their job and rolls over their account to their new employer.
Borrowing from retirement plans presents hazards to the employer, as well. More employers are minimizing the ability of employees to dip into their 401(k) savings by limiting the number of loans from 66% in 2012 to 45% in 2016, according to SHRM. Despite this, the bottom line is that employees need access to low cost credit.
More than 1-in-4 participants use their 401(k) savings for non-retirement needs, according to financial education provider HelloWallet. That amounts to a startling $70 billion of retirement savings that employees are siphoning away from their future.
There are hidden costs to 401(k) loans. One of the perceived benefits of a 401(k) loan is that the borrower isn’t charged any interest. That’s a fallacy: 401(k) loans typically include interest rates that are 1 to 2 points higher than the current Prime Rate plus administrative fees. While the borrower pays this money to him or herself rather than to a bank, these “repayments” don’t take into account penalty of taking money out of a 401(k) for months or years when it might have enjoyed market gains.
The downside of the interest rate is that it makes paying back the loan more difficult and this will likely lead to 401(k) leakage. In some cases, loopholes that allow employees to raid their 401(k)s before retirement reduce the aggregate wealth in those accounts by 25%. Simply put, this translates into having the most senior and highest paid employees stay on the job because they do not have enough funds in their account to retire. From an HR administrator’s standpoint, that can increase overall costs, since employees who cannot afford to retire are drawing higher-than-average salaries. And thanks to their advanced age, they also run-up costs on the employer’s medical plan.
The financial wellness alternative
Employers should offer socially responsible alternatives to borrowing from their 401k. Not only to ensure that older workers can afford to retire and make room for younger, less-expensive hires, but to ease the financial burden for employees when emergencies do happen. This should be offered as a voluntary benefit with no risk to employers. In a recent Wall Street Journal article, “The Rising Retirement Perils of 401(k) ‘Leakage’” Redner’s Markets made that leap offering a low-cost Kashable loan to its employees. It stopped leakage and offered employees of the online grocer much needed relief from financial stress.
Adding a financial wellness solution to the employee voluntary benefits package that provides access to responsible credit is a first step in untangling employees’ financials. For employees struggling with college loans and credit card debt, this financial-wellness benefit allows them to borrow when needed at a low rate. For the 35% of employees surveyed by PWC in 2016 that said they had trouble meeting their monthly household expenses and the 29% that said they had trouble meeting their minimum credit card charges each month, this voluntary program provides multiple benefits. For the employee, it is an opportunity to build or improve their credit score, and provide relief from financial stress. To the employer, it’s a risk-free solution to stop the leakage from retirement accounts.