NEW YORK (MainStreet) — Putting money into your 401(k) is one thing; however, keeping it there apparently is quite another for many Americans.
Nearly one million 401(k) investors have initiated a loan from their 401(k) account in the last year, according to a new study by the financial investment firm Fidelity. Perhaps even more damaging to people’s long-term retirement goals, some investors reduce or stop saving in their accounts altogether to help pay back the loan.
“The number of investors borrowing from their 401(k) has trended upwards in recent years, with more than two million investors now having an outstanding loan,” said Doug Fisher, senior vice president of Fidelity’s Thought Leadership and Policy Development.Read More: IRA Alternative: Roth Your 401(k)
The research shows within five years of taking a loan, 40% of borrowers decrease their savings rate, and more than a third of those stop saving altogether. The long–term consequence of this new trend can be devastating to both who have stopped saving and even those that just have cut back on their 401(k)s — such as the potential loss of up to hundreds of dollars in monthly retirement income.
To illustrate the effects of reducing one’s contributions can have, the study looked 401(k) investors who started saving at age 25 – 6% employee contribution and a 4% employer contribution for a 10% total savings rate – with an annual salary of $50,000. When one cuts his savings rate in half for just five years, the estimated monthly retirement income from his account drops from a $2,650 to $2,470.
“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,” Fisher said. “Reducing your savings rate today could significantly reduce your account balance upon reaching retirement and therefore your monthly income in retirement.”
The study revealed through the past year alone, more than 27,000 investors took loans specifically for the purchase of a home — a trend the company has seen increasing through the past five years. The trend likely is not surprising with the average home loan today at $23,500 — significantly higher than the average general loan of $9,100. The amount represents 25 percent of an average borrower’s 401(k) pre-loan balance — versus 17% for a general loan.
Perhaps not surprising, the group most affect by borrowing from their 401(k) accounts are the younger generations. Millennials borrow on average 37%, or $17,100, of their retirement savings balance for a home. A greater portion of Gen X-ers took home loans than Millennials, but their averaging was slightly lower at $25,600, or 26% of their balance.
The study points out that borrowing so much could stretch these young peoples’ budgets, especially when one considers many also may have a mortgage, as well as significant student debt. Borrowing just a quarter of a person’s balance during these early income years makes it all the more difficult to stay on track with retirement savings if they reduce or stop saving. According to Fidelity, Gen X-ers should have at least a full year’s salary saved for retirement at age 35 and three years at 45.
If one does borrow against their 401(k) accounts, the analysis said borrowers should keep in mind a few in particular, such as if you move to a new job, any outstanding 401(k) loan balance typically must be repaid within 60 days.
Despite the dangers, the study does agree there may be times when a 401(k) home loan is a useful option for investors. However, people need to be wary and carefully weigh all their options when considering such a loan, and seek professional help.--Written by Chris Metinko for MainStreet