In the survey by TIAA-CREF, paying off debt was cited as the top reason for taking out a loan from retirement plan savings (46%), yet only 26% of respondents said paying off debt was a good reason to take out a loan. The second most common reason overall for taking a loan was to pay for an emergency expenditure (35%). Other common reasons included a home purchase or major renovation (26%) and paying bills during a period of unemployment (24%), while still others borrowed against retirement savings to cover education costs (20%) or the expense of a wedding or vacation (15%).
Women were more likely than men (52% versus 41%) to take out a loan to pay off debt. However, men were more likely to take out a loan to pay for an emergency expenditure (40% versus 29%), according to the research. TIAA-CREF says nearly half of those who have taken out a loan from their retirement plan savings borrowed more than 20% of their savings, with 9% of respondents borrowing more than 50%.
The wide use of defined contribution plan loans is having a significant impact on Americans’ retirement security, TIAA-CREF contends in its Borrowing Against Your Future Survey report. Loans present two distinct problems: Participants lose out on the potential earnings these borrowed savings could earn if allowed to stay in the markets, and more half of all loan-taking participants decrease contribution rates while paying back the loans, further jeopardizing their retirement readiness.
The survey found more than half of respondents (57%) who took out loans decreased their contribution rate during the payback period. Those ages 18 to 34 were the most likely to decrease their contribution amount (81%). Forty-eight percent of women kept the same contribution rate while paying back the loan, compared to only 39% of men.
"Too many people have struggled since the 2008 financial crisis and have looked at loans from their retirement plans as a way to ease financial stress,” explains Teresa Hassara, executive vice president of TIAA-CREF’s institutional business. “However, individuals should weigh all of their options carefully before borrowing from their plan savings or reducing their contributions.” It’s important to evaluate the benefits of taking a loan now against the need for those earnings to build long-term retirement security, she adds. “Working with a financial adviser can help people make the best decision for their life stage and retirement goals.”
TIAA-CREF recommends plan sponsors consider limiting participants to three loans each from their retirement savings. These loans should come from participant contributions rather than employer contributions. This will encourage employees to focus on long-term planning during the accumulation years. Limiting loans also can keep down plan expenses and have a positive impact on overall plan fees.
Plan advisers can serve as an important educational resource for employees, but employers also have an important role to play, TIAA-CREF says. In fact, according to a survey the firm released in February 2014, 81% of Americans trust financial information offered by their employer, a greater percentage than those who trusted financial information offered by a traditional financial institution, such as a bank or retirement plan provider. Employers can use this trusted status to provide credible options about alternatives to loans from retirement savings.
“If loans are necessary to cover an emergency or the loss of a job, people should seek advice to minimize the loan’s long-term impact on their retirement savings,” Hassara explains. “It’s a good example of why plan sponsors should make financial education and advice a core component of their plans.”
An executive summary of the survey is available here. TIAA-CREF also has prepared articles for plan sponsors and individuals that discuss how they can ensure that retirement plan loans are not undermining retirement readiness.