Credit Crisis Affecting 401(k) Plans

The Financial Advisor Magazine is reporting, "Credit Crisis is Affecting 401(k) Plans".

More 401(k) plan participants are using their own plans as a source of income—either by requesting a hardship withdrawal, taking a loan, or just lowering or eliminating their contributions, according to a new study by Anne Lester, managing director and senior portfolio manager of JPMorgan Funds.

There are some sobering thoughts presented here. The impact of loans and hardship withdrawals is taking on a special significance:

Nearly 20% of companies across the country have reported increases in loans and hardship withdrawals from their 401(k) accounts in the past quarter; 43% of these companies noted these loans and withdrawals were used to make mortgage payments, she notes. Other reasons cited included the need to cover personal bankruptcy, supplement normal spending or cover a family emergency. The correlation between market volatility and erratic savings behavior is most compelling in areas with high foreclosure rates, she adds.

As home sales plummeted in 2006 and particularly during the last half of 2007, these locations—particularly the South Atlantic, Midwest, and Southwest—not only experienced double the number of foreclosures since 2006, but 50% to 60% of plans in these areas also saw an increase in loans and withdrawals. As foreclosure rates rose to more than 2.5% in the state of Georgia, for example, one plan observed a 15% increase in loans. That same plan reported that 29% of participants had outstanding loans in the second half of 2007.

But the impact of loans and withdrawals on retirement plans was not limited to just those areas with high foreclosure rates. “During the height of the housing boom, all plans in our sample reported a 15% decline in outstanding loans. But when real estate values plummeted and the mortgage crisis began in 2007, these plans reported a 6% increase in the number of participants taking loans and a 6% increase in hardship withdrawals, with 74% of plans reporting an increase in the number of loans and/or withdrawals,” she says.

The perils of buying high and selling low are revisited:

The impact of participants’ loans and withdrawals during this period of market volatility is expected to become even more significant over time, she says. “For example, participants now borrowing from plans during the current market downturn are selling assets at depressed values to fund the withdrawals. As a result, when the markets begin to rally at some point, participants are likely to be partially out of the market during the most crucial years for building capital, and will be forced to save more than they removed to get back to where they started in the first place,” she says.

Some pointers for advisors on how to deal with clients:

Lester offers several steps to help clients address negative behavioral patterns affected by the current market volatility. For the short term, she suggests selecting highly diversified target-date funds that are well positioned to overcome negative behavioral influences and deliver downside protection. For the long term, she says, advisors need to educate and communicate with clients on an ongoing basis.

[Emphasis added]

WSJ on 401(k) Debit Cards

So as not to be left behind in the debate over 401(k) debit card loans after the New York Times report I wrote about last week, the Wall Street Journal's Jonathan Burton reports [subscription required]: "Critics Detail the Ills Of 401(k) Debit Cards." In this report, Mr. Burton quotes several adverse reactions from the who's who in the retirement and financial planning world. Some choice comments:

"We absolutely hate it," said Jean Setzfand, director of financial security at AARP, the organization for people 50 and older. "A 401(k) loan is a last resort."

"A horrible idea," said Linda Lubitz Boone, president of investment advisory firm Lubitz Financial Group in Miami. "It's hard enough to save to begin with."

Even official watchdogs are on alert. The Financial Industry Regulatory Authority issued a stern warning about 401(k) debit cards, calling them "a tempting convenience that can have significant repercussions" on your retirement security.

The cards also have become Public Enemy No. 1 for some Washington lawmakers; Sens. Charles Schumer (D., N.Y.) and Herb Kohl (D., Wis.) blasted them this month as an apparent abuse of 401(k) plans and proposed legislation to outlaw them.

The heightened controversy about 401(k) debit cards comes with the times. There is an increasing concern that with things so tough, people living paycheck to paycheck will increasingly turn to retirement savings as a source of cash. Mortgaging your future, unless it is for an emergency or to enhance your education or career, is almost always a poor decision. You will have less money to support yourself after you retire or you will have to work more years before calling it quits.

The report does list some advantages of such loans over regular 401(k) loans:

For starters, the ReservePlus card is flexible; it can be used multiple times, for any purpose. As with a typical loan, employers set a borrowing limit based on how much you have saved for retirement. By law, the upper limit is generally $50,000 or 50% of your account balance, whichever is less. The approved amount is set aside in a money-market fund and earns tax-deferred interest until you use the card.

With every transaction, you have five years to pay back the money, and the interest rate -- now about 8% -- may be better than certain people can get elsewhere.
One advantage of a debit card is that if you are laid off or leave the company, there may be no pressure to reconcile the debt immediately. With a typical 401(k) loan, the outstanding amount must be repaid in full, usually within 90 days. Otherwise the loan amount is considered a taxable distribution.

I am sure of one thing: we have not heard the last word on this controversy yet.

Where to Spend a 401(k) Debit Card Loan? Choices... Choices...

The New York Times (Ron Lieber) is reporting on the use of 401(k) Debit Cards, and efforts underway by Senators Chuck Schumer (D-NY), and Herb Kohl (D-WI) to ban their use. The one company that offers this feature is called Reserve Solutions. If such debit card loans were to be outlawed or curbed, I will speculate that the one trick pony business model of Reserve Solutions could cause it to fail as a company.

Ron Lieber at NYT interviewed both Senator Schumer and the founder and chairman of the parent company of Reserve Solutions, Bruce Bent. It makes for a very interesting reading - I highly recommend reading the whole thing. Some excerpts:

Q. How did you first get interested in creating legislation around debit card access to 401(k) loans?
SCHUMER Over 10 years ago, I read in the paper that Bank One was offering access via a card to 401(k) loans, and I thought, this is outrageous. America has to save. If people need to access their 401(k)s because of unusual circumstances, that’s one thing. But to encourage people to take money out with a card is encouraging all the wrong values. So I said then that I was going to put forth legislation, and the bank dropped it and I thought it was over.

...

Q. Is this really that much different than simply going online and moving loan money from Fidelity or another 401(k) account administrator to your bank account?
SCHUMER It is totally different. A debit card allows people to spend on impulse. Not having one attached to a loan is sort of like having a waiting period for a gun.

Q. Are there particular types of workers to whom the debit card is especially appealing?
BENT It’s bringing in lower income and younger workers. They don’t come into the 401(k) plan in the first place because they’re unhappy with the concept of losing access to their money. Or invariably, the plans and the loans don’t work for them because they’re transient, working for one construction company at one time and another during another season.

Q. One plus of a debit card is that the issuer can see how people are actually using their money. So are they spending it on frivolous things?
BENT I can’t say. It’s proprietary, and it’s also personal information.

Q. Could an employer see that information?
BENT Well, if you outlaw the debit card, Big Brother’s ability to control expenditures is limited. They can’t control it then. With a debit card in place, Congress could dictate to us that Vendor 23, Victoria’s Secret, or Vendor 85, Joe’s Massage Parlor, don’t qualify. Or they could restrict entire categories of vendors where people could spend the money.