Every car has a reverse gear. You use it to get out of trouble. But you generally don't use it much because it can also get you into trouble. If you're like me, you avoid using reverse like the plague. Really. I always search for a parking spot I can drive through – just so I don't have to back out when it's time to leave. This might be a psychological response to the time I would back out of the driveway as a teenager. You remember that, don't you? I failed to check my blind spot and knocked over the family basketball hoop; thus, symbolically ending my childhood and putting a dent in my father's new car simultaneously.
Unless you're a Hollywood stuntman, you don't use reverse to drive a car forward. After all, they don't say it's hard to drive by looking at the rear view mirror for nothing. For most of us, putting the car in reverse means delaying the arrival to our ultimate destination. Sometimes we take a wrong turn and we have to back up to return to the correct course. Sometimes someone stalls in front of us and we have to back up to get around the obstacle. If we could just go straight to our journey's end, we would avoid reverse altogether and proceed full speed ahead.
The same applies to your 401k. If you'd have your druthers, you'd go full speed ahead to retirement readiness.
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Alas, if only 401k plans kept us on the straight and narrow highway the same way IRAs do. You see, unless you're incredibly clever (and, some say, willing to enter into certain grayish areas), you can't take out a loan from an IRA. In fact, unless you're willing to subject yourself to the harsh penalties of Uncle Sam's tax collector, you can't even take out a hardship withdrawal, no matter how much you might need it.
Too bad the DOL doesn't put similar restrictions on 401k plans, although not everyone agrees with this sentiment, (see "How Should the 401k Fiduciary Address 'Leakage'?" FiduciaryNews.com, November 26, 2013). One estimate states that 80% of loans outstanding upon separation from employment do not get repaid. But the negative impact of loans is dwarfed by so-called hardship withdrawals and post-separation distributions.
According to employee benefits attorney Jack Towarnicky, a 2009 study of the 401k plan universe by the GAO showed loan defaults totaled only $670MM while post-separation distributions ($74B) and hardship withdrawals ($9B) accounted for a far greater portion of plan leakage. More importantly, this leakage occurs most often among younger participants who have the most to lose (in terms of compounded returns) from such pre-mature distributions.
There are many ways to make mistakes. Too many to list. Some occur out of pure random luck. Some occur from our own doing. The worst, though, sneak up on us under the guise of goodness, only to reveal their true malevolence when it's too late to do anything about it.
These 401k "benefits" end up hurting one's ability to achieve retirement readiness. Not all plans offer these features, but, even the absence of these perks has its own downside. There's no true consensus on the best policy regarding whether a plan sponsor should provide these perks within the plan design. There is, however, one point everyone agrees on: If it's at all possible, avoid using these hidden inhibitors.
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Christopher Carosa
Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).
