This year, a lot of hot air is circulating in Washington about the problem of 401(k) leakage.
Sen. Tom Harkin, D-Iowa, chairman of the Senate Health, Education, Labor and Pensions Committee, advocates proposed legislation to create USA Retirement Funds, which would guarantee a lifetime income by merging defined benefit options into 401(k)s.
Sens. Bill Nelson, D-Fla., and Mike Enzi, R-Wyo., have re-introduced their SEAL Act, which would lessen the potential damage to retirement savings caused by taking loans and hardship withdrawals.
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There are basic problems with both approaches.
Some 401(k)s already offer defined benefit options, but these choices aren't widely used – mainly because current interest rates are so low that lifetime income streams guarantee a pittance. The SEAL Act could make loans and hardship withdrawals more attractive to take, which wouldn't help Americans address the problem of inadequate retirement savings.
Tell your clients not to wait for Congress to improve retirement plans.
A more immediately effective strategy is to offer them counseling on what the impact the loans or hardship withdrawals will have on long-term retirement savings. In general, loans should be taken before withdrawals, and the client should commit to a loan repayment discipline.
Surveys have shown that about a quarter of 401(k) participants have loans outstanding and loans often are used to pay down other higher-rate debt.
If a 401(k) loan is paid back on time, prior to retirement or separation from service, and the loan is used to pay down other debt, it can actually have a positive impact on retirement savings.
A useful calculator to show this point is free from CalcXML here: www.calcxml.com/do/qua10.
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