Loans May Have Ripple Effect on Retirement Plan Savings

Taking a retirement plan loan can have a big impact on a participant’s retirement income, especially if the participant does not pay the loan back or stops contributing to the plan at the same time.

“The number of investors borrowing from their 401(k) has trended upwards in recent years, with more than 2 million investors now having an outstanding loan,” says Doug Fisher, senior vice president of thought leadership and policy development for Fidelity Investments. “Fidelity’s top concern is that within five years of taking a loan, 40% of borrowers decrease their savings rate, and more than a third of those stop saving altogether. Reducing your savings rate today could significantly reduce your account balance upon reaching retirement and therefore your monthly income in retirement.”

Fidelity conducted a hypothetical analysis of three 401(k) investors with an annual salary of $50,000 who started saving at age 25 with a 6% employee contribution and a 4% employer contribution for a 10% total savings rate. At age 35, one investor reduced his deferral to 0% for 10 years, one reduced his deferral rate so that his total savings rate was 5% for five years, and one maintained the 10% total savings rate. Based on certain assumptions, Fidelity found the first two experience a decrease in monthly income in retirement of $690 and $180, respectively.

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According to Fidelity, over the past year alone, more than 27,000 investors took loans specifically for the purchase of a home. While it’s a small percentage of Fidelity’s overall 401(k) loan-taking population, it is a trend the company has seen increasing over the past five years. Today’s average loan for home-buying is $23,500, far higher than the average general loan value of $9,100. It represents 25% of an average borrower’s 401(k) pre-loan balance, versus 17% for a general loan.

Millennials borrow on average 37%, or $17,100, of their retirement savings balance for a home. According to Fidelity, borrowing so much at this young age could be a stretch for people who are also taking on a mortgage and might be saddled with student debt.

A greater portion of Gen X took loans for home-buying than Millennials or Boomers, averaging $25,600, or 26% of their balance. Borrowing one-quarter of a person’s balance during these crucial income years makes it all the more difficult to stay on track with retirement savings if they reduce or stop saving, according to Fidelity. Fidelity’s savings rule of thumb indicates Gen X should have an amount equal to a full year’s salary saved for retirement at age 35, and an amount equal to three year’s salary at age 45.

Fidelity contends participants considering a loan should be reminded of three implications:

  • If moving to a new job, any outstanding loan balance typically must be repaid within 60 days. Plan rules may vary.
  • Borrowers unable to continue saving at the same pre-loan rate while repaying their loan may adversely impact their monthly retirement income.
  • Loans are paid back with after-tax dollars, which can negatively impact the tax-deferred savings benefits of a 401(k).

Schwab Introduces Low-Fee Passive TDF Share Class

Charles Schwab Bank launched a new share class for the passive Schwab Indexed Retirement Trust Funds (SIRT Funds), featuring a 0.08% expense ratio and a $100 million minimum investment.

Schwab says it expects the low-fee SIRT Fund share class to “have an interesting impact on the competitive landscape for target-date funds [TDFs] within 401(k) plans.” The firm suggests demand for passive investing strategies is increasing among both plan sponsors and participants, and there is especially strong demand for low-cost passive TDF strategies within 401(k)s.

The new SIRT Unit Class II provides large and mid-sized plans a fully passive solution at extraordinary value, Schwab says, contending that the funds are among the lowest priced industry-wide. For smaller plans, SIRT Unit Class I shares are available at 0.14% operating expense ratio and no minimum investment.

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The SIRT funds also have a broad asset class diversification, providing exposure to commodities, emerging markets, global real estate investment trusts (REITs), and more.

The SIRT Funds are collective trust funds that have an open architecture design, which Schwab says can address the concerns of sponsors worried about conflicts of interest with all-proprietary approaches. Schwab explains that this type of thinking has accelerated since the Department of Labor published TDF selection tips for plan fiduciaries last year, and identified potential the benefits of low-cost, open-architecture TDFs.

The new SIRT Unit Class II will be available to plans starting December 1.

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