The study, “Diversity and Defined Contribution Plans: Loans and Hardship Withdrawals,” also notes that a 401(k) loan feature encourages some people to participate and save in their 401(k) plan. Thus, employees who participate in a plan and take a loan or hardship withdrawal are likely to be better prepared for retirement than coworkers who do not participate and have no retirement plan savings.
Borrowing from a 401(k) plan does raise the potential concern that monies intended for retirement may be diverted to other purposes. The researchers suggest that plan sponsors who are concerned about this can take steps to reduce 401(k) borrowing.
“The incidence of 401(k) loans is significantly higher in plans that allow multiple loans. As a best practice, sponsors should consider limiting participants to one loan outstanding and/or other modest borrowing restrictions. This strategy appears to reduce borrowing levels across all participants, and all racial and ethnic groups,” said Cyndy Pagliaro, a Vanguard researcher and lead author of the report.
Loans from 401(k) plan accounts, which are generally limited to half the account balance (up to a maximum of $50,000), must be repaid via payroll deduction, so the money is eventually replaced unless the participant leaves the company and defaults on the outstanding loan balance.
Blacks in the study were 55% more likely to take a loan than whites or Asians. Hispanics were about one third more likely to take a loan. However, the amount borrowed was only slightly higher among blacks, Hispanics and Asians than whites. There were no meaningful differences in loan default rates among the groups.
Hardship withdrawals are generally limited to an employee’s contributions and must typically meet certain criteria, such as an eviction or foreclosure notice, certain medical expenses and similar criteria. Unlike loans, they do not have to be repaid and thus represent a known reduction in a participant’s retirement assets. Blacks were almost twice as likely to take a hardship withdrawal as whites, but withdrew around 3.5% less of their account balance than whites and
Hispanics. Asians were excluded from the hardship withdrawal analysis because they made so few that the sample size was not meaningful. Hispanics were about one third more likely to take hardships as whites, and withdrew a similar fraction of their account balance as whites.
Behavioral differences in borrowing and hardship withdrawals may reflect other factors the researchers noted they could not measure among the groups—such as differences in financial literacy, trust in financial institutions or restricted access to credit outside the plan.
The study looked at 2010 data for approximately 250,000 participants in seven large defined contribution plans
with Vanguard as recordkeeper. One of the plans restricts participants to a single loan while the others allow two or three loans at one time. Conforming to Internal Revenue Service definitions, each plan allows participants early withdrawals because of financial hardship.
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