Legislation Aims to SEAL 401(k) “Leakage”

According to a press release, Senators Herb Kohl (D-Wisconsin) and Mike Enzi (R-Wyoming) have introduced the Savings Enhancement by Alleviating Leakage in 401(k) Savings Act of 2011, or the SEAL Act, will protect Americans’ retirement savings “by providing flexibility to loan repayment hardship tax rules and limiting the most 401(k) loan practices that provide easy access to retirement funds but adds costs and fees to pension plans”.

“As the frequency of retirement fund loans have gone up, the amount of money people are saving for their retirement has gone down,” Kohl said. “The gap between what Americans will need in retirement and what they will actually have saved is estimated to be a staggering 6.6 trillion dollars. While having access to a loan in an emergency is an important feature for many participants, a 401(k) savings account should not be used as a piggy bank.”

The legislators noted that because of the difficult economic times, more and more Americans are treating their retirement accounts as rainy day funds by taking out withdrawals and loans from their employer sponsored 401(k)’s and then are unable to pay themselves back, a result frequently referred to as “ “leakage.” 

“While our nation’s 401(k) retirement system is providing greater opportunities for individuals to save, there is still room for improvement. Recent studies have shown that money saved in retirement accounts sometimes ‘leaks’ out of the system and is never put back,” said Senator Mike Enzi (R-Wyoming). “Today, I am joining with Senator Kohl to take the first step to help to stop leakage in the retirement system by introducing legislation to help workers and their families to pay back loans from retirement accounts when a worker leaves a job. Our bill would allow for a greater period of time for the loan to be paid back thereby helping families pay back the loan and allowing the funds to be put back into their retirement savings and avoid the tax penalty.”

According to the press release, this legislative effort is rooted in the findings of a 2009 report by the U.S. Government Accountability Office (GAO) examining the long-term effects of 401(k) loans and leakage on workers’ retirement savings. The report highlighted various policy changes to reduce these effects, urging Congress to take legislative action to change contribution suspension requirements triggered by hardship withdrawals. 

As for specific provisions of the SEAL Act:

Extends rollover period for plan loan amounts: When an employee with a 401(k) plan loses his or her job, he or she often faces the tough choice between defaulting on his or her outstanding loan and incurring tax penalties or immediately repaying the entire outstanding loan balance.  The SEAL Act allows an employee to contribute the amount outstanding on their loan to an IRA by the time they file their taxes for that year.

Allows 401(k) participants to continue to make elective contributions during the six months following a hardship withdrawal: Currently, after an employee receives a hardship withdrawal from a 401(k) plan, she or he is prohibited from making elective contributions to their retirement account for at least six months.  The loss of both employee contributions and company matching contributions during this period can exacerbate negative the long-term effects on retirement savings. The SEAL Act allows participants to continue to make contributions during the six months following a hardship withdrawal.

Reduces the overall number of loans that participants can take at one time to three: While it is important for participants to have access to their savings in times of need, the administrative burden of managing multiple loans for a few individuals can increase the costs for all workers in a plan. The SEAL Act reduces the overall number of loans that participants can take to three at one time.  Currently employers determine the number of loans available, and many employers, like the Federal Thrift Savings Program, have chosen to limit the number of loans to reduce leakage and overall cost.

Bans products that promote leakage, such as the 401(k) debit card: Certain products actively encourage participants to tap into their savings before retirement, often accruing large fees in the process.  One such product is a debit card linked directly to one’s 401(k) savings account, according to the press release.  “Although 401k debit cards are not currently prevalent, a number of different companies have offered them in the past and some companies continue to market these cards online,” according to the legislators. 

The full text of the bill is available at http://aging.senate.gov/issues/FSA.pdf