Consumers increasingly take loans from retirement plans

With the economy deteriorating and prices for gas and heating fuel skyrocketing, consumers who are seeking new sources of cash are increasingly jeopardizing their retirement income by taking out loans from their retirement plans.

The number of such loans has been growing at double-digit rates, according to top plan providers.

“People are struggling now, and the country hasn’t seen a serious recession since 1980,” said Alicia Munnell, director of the Center for Retirement Research at Boston College in Newton, Mass.

“With rising prices, it’s tough,” she said. “The withdrawals and loans are a sign of how pressed people feel.”

The T. Rowe Price Group Inc. reported that loans from retirement plans it manages were up 10% in each of the past two years, and the trend has continued in 2008, with loans in January and February up 6%, compared with the first two months of 2007.

Total loan amounts from the plans were up about 11% in each of the past two years. Total loan amounts in January and February were about 7% higher than for the same months in 2007, according to the Baltimore-based firm.

The number of hardship withdrawals increased 32% in the first two months of 2008 compared with the same months last year. The amount withdrawn for those months was up 37% over the same period in 2007, ac-cording to the firm.

As of December 31, there were 1.6 million participants in the plans, and the firm managed $162 billion in defined contribution assets.

The Merrill Lynch Retirement Group of Pennington, N.J., reported a similar trend in its proprietary business of 1,500 clients, representing 2.6 million participants and $103 billion in assets.

The firm, a subsidiary of New York-based Merrill Lynch & Co. Inc., said that between the first and fourth quarters of 2007, the number of general-purpose loans from 401(k)s increased 14%, while residential loans decreased 40% and hardship withdrawals jumped 42%.

“We do a lot of education on our website and in statements,” said Kevin Crain, managing director for business retirement and corporate market integrated benefits at Merrill Lynch. “They have the right to take out loans, but we want them to think about some of the issues.”

At Great-West Life and Annuity Insurance Co., the number of hardship withdrawals from employer-sponsored defined contribution plans rose 56% to 709 in January 2008, from 454 in January 2007, with 42% of those related to eviction or foreclosure, said Charles Nelson, senior vice president at the Englewood, Colo.-based company. Residential loans fell 74% January over January, while general-purpose loans increased 13% for all of 2007 versus 2006.

The unit of Great-West Life Assurance Co. manages 20,000 different plans with 3.5 million participants and has $135 billion in assets.

Fidelity Investments reported that the number of loans taken by participants in 401(k) plans administered by the Boston-based firm’s retirement services division increased in 2007 by just under 4% from 2006, according to company spokesperson Jennifer Engle. Fidelity declined to -disclose the number of plans or assets it has under management or the number of participants.

The company also saw a 17% increase in hardship withdrawals between 2006 and 2007. In total, the number of participants making hardship withdrawals is just over 1%, Ms. Engle said.

Data for 2008 weren’t yet available, according to Fidelity.

Hewitt Associates, a Lincolnshire, Il.-based global human resources firm, reported in-creases as well.

In a survey of some 1.9 million participants, 22.3% took out loans last year, compared with 21.8% in 2006. The number of withdrawals also rose to 5.4% in 2007, from 4.9% in 2006.

For 2008, Hewitt is seeing a similar trend, though it hasn’t yet released any figures.

“We seem to be on track again to not have a very big difference over last year,” said Pam Hess, director of retirement research. “I think there will be a marginal increase in loans and withdrawals.”

The impact of taking out a loan can be significant, experts say.

“If you take out a loan and repay it over five years, the [401(k)] plan suspends your contribution for five years,” Ms. Munnell said. “You’ll end up with 82% of what you would have if you left the money there.”

If the participant defaults on the loan and suspends contributions for two years, the participant will get 84%, Ms. Munnell said.

In a sign of the times, Reserve Solutions Inc., a subsidiary of The Reserve, a New York-based fund company, offers a debit card that allows investors to tap their 401(k) plans for loans.

The ReservePlus card is a Visa debit card that allows participants to make one application and secure multiple loans. The typical interest rate is the prime rate plus 2.9%, according to the firm.

Participants can take out multiple loans with the card, but end up withdrawing less, said Eric Lansky, spokesman for The Reserve. While the average 401(k) loan is about $8,000, according to 2006 data from the Employees Benefit Research Institute of Washington, the average loan through the ReservePlus program was $4,852 as of March 17.

“People can borrow exactly what they need, when they need it,” Mr. Lansky said.

The card has several thousand participants, he said.

The program, which began three years ago and was re-launched last year, is drawing criticism.

“The debit card is just crazy; we already have a savings problem in this country,” said Mike Scarborough, president of Scarborough Capital Management Inc. of Annapolis, Md., which has $1.7 billion in assets under management.

Participants shouldn’t be allowed to borrow money from 401(k)s willy-nilly, he said.

“It’s not a savings plan; it’s a long-term retirement account. I cannot see people taking money out for anything less than a hardship withdrawal,” Mr. Scarborough said.

“Unless it’s a crucial situation, it loses the purpose of having deferred returns over time for retirement,” said Robert Wasilewski, financial adviser and portfolio manager with Baltimore-Washington Financial Advisors. The Columbia, Md., firm has $200 million in assets under management.

A home equity line of credit is one strategy that could be used instead, said Drew -Tignanelli, principal and president of The Financial Consulate, a Lutherville, Md., firm that doesn’t disclose assets under management.

“I strongly encourage clients to get to the bank and get the largest home-equity line of credit approved that they can,” he said.

“Once you get approved for it, it’s there and it’s in place,” Mr. Tignanelli said. “The worst time to ask the bank for a loan is when you need it.”

And if bankruptcy appears inevitable, Mr. Tignanelli advises clients to leave the money in their 401(k)s. “The 401(k) is protected under the bankruptcy law” he said.

Although he doesn’t think people should take out loans from their 401(k)s, it could be acceptable as a short-term solution, said David Greene, vice president CJM Wealth Advisors of Fairfax, Va., which has $400 million in assets under management.

“It’s better than jumping on a credit card for 18 months,” he said.

E-mail Sue Asci at [email protected].