Financial Wellness

The 401(k) loan epidemic

Why millions of Americans are borrowing from their futures just to make ends meet.
401k

If you do a Google search for “401(k) loan,” you’ll get about 50 million results in half a second. Most of these articles list the pros and cons of borrowing from one’s retirement. The prevailing tone is that it’s a bad idea. Yet plenty of people seem to be searching for information on if, and how, they should do this. In fact, MetLife recently found that 22% of workers aged 23–36 have borrowed from their 401(k) accounts; 26% of millennials have done the same. Overall, nearly a third of U.S. employees have borrowed from the funds that are supposed to keep them afloat in their later years.

A line graph showing that searches for “401k loan” have gone up from about 35 million in 2004 to about 60 million today.

Search trends for “401k loan” are going up

The number of people looking for information on borrowing from their retirement funds has been steadily increasing over the years. But, borrowing from a 401(k) comes with plenty of drawbacks. The loan has to be repaid with interest, usually within five years. And even though the money will be eventually put back into the account, those funds have lost out on years of investment growth. If the loan isn’t paid back on time, it could convert to a distribution, which is heavily taxed.

And while young people might have “plenty of time” to rebuild their savings, the truth is that millennials are already behind when it comes to saving for retirement. And over 50% of boomers have already tapped their accounts. So why is this happening?

Robbing the future to pay for the present

Nearly 55% of Americans are living paycheck to paycheck, and 40% couldn’t come up with $400 in an emergency. So when emergencies do happen — a lost shift, or broken down car — people often switch into what’s called a “scarcity mentality.” For someone in this state, the inability to put gas in the car or pay rent is the primary driver for their thoughts and actions.

Solving the crisis becomes the top priority, and even solutions that have far-reaching implications can seem attractive. That means $5,000 sitting in a 401(k) account, designated for long-term goals, can look like a very attractive solution to a short-term problem.

This helps explain why loans from 401(k) plans, which spiked in the years immediately after the Great Recession, have still not returned to normal. Around a fifth of people with 401(k) plans currently have active loans against their account. Of the $294 billion deposited in 401(k) plans each year, around $70 billion is siphoned off for non-retirement expenses. And every dollar taken out of a plan is a dollar that can’t be spent in retirement, precisely when someone will need it most.

Why should businesses care about this?

According to Fidelity, employees who borrow against their 401(k)s are more likely to reduce or stop their contributions in the future. And it’s not just people taking out actual loans whose 401(k)s are affected. Employees struggling to make ends meet with their regular paycheck often choose to cut back on their 401(k) contributions. And then there’s the 38% of people who don’t participate in a 401(k) plan at all.

All this matters because the point of 401(k) plans is to help employees plan for their retirements, and live fulfilling lives when they’re done with their working years. But there’s another big factor at play: Healthy 401(k) programs have a direct effect on the success of the companies that offer them.

Whether it’s reduced participation, or no participation whatsoever, employers are missing out on tax benefits and retention impact. For example, if an employer offers to match employee contributions, they can deduct those contributions from the corporate federal income tax return. These funds are also often exempt from state and federal payroll taxes. Those deductions help offset the cost of offering the 401(k) in the first place.

In addition, a study by T. Rowe Price found significant correlations between a company’s profitability and the strength of its 401(k) plan participation. According to the study, companies with higher participation and account balances are have 20–80% higher corporate profitability than companies with average plans.

The study also found that companies with “great” plans — defined in part by larger salary deferrals, higher participation, and larger account balances — have higher per-employee productivity and revenue. If employees are lowering their contribution rates, or not participating in their plans at all, businesses stand to lose out on these significant benefits.

A path towards healthier 401(k) engagement

Employees are embroiled in debt, and often unable to meet everyday expenses. To make ends meet, a startling number of workers are borrowing from their futures to solve crises in the present. Not only does this put the retirements of millions of workers in jeopardy, but it’s bad for business, too: Employers reap the highest benefits when 401(k) participation is robust, and employees are prepared to retire on time.

If employees had a way to absorb cash-flow emergencies on their own, there would be less need for them to borrow from their 401(k) accounts. Sendhil Mullainathan and Eldar Shafir, authors of the pioneering work on the scarcity mentality, suggest that the best way to do this is to offer employees a tool that helps them build their savings. When employees have those savings, there’s less need to dip into retirement funds to cover emergencies.


Want to learn more? Download our newest e-book: A Guide to Financial Wellness: The Employer’s Handbook for Understanding On-Demand Pay and Financial Wellness Benefits.

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