Employee borrowing from 401(k) plans increased 28% in the fourth quarter from a year earlier, according to Wells Fargo as over 60% of new loans went to individuals heir 50s and 60s.
“The increase in new loans is a bit sporadic, but over the past two years the overall trend is a gradual increase in the percentage of participants with an outstanding loan,” Elli Dai, senior vice president and director of participant services at Wells Fargo Retirement, said.
The Wells Fargo data, which iss based on an analysis of a subset of 1.9 million eligible participants in retirement plans that the company administers, reveal that 19.2% of the people with money in a 401(k) plan had at least one outstanding loan at the end of last year.
The challenges in the current economy could be one reason more people are taking out loans, Dai said. “The unemployment rate in particular may be driving the employed spouse of a married couple to take a loan to cover expenses while the other spouse continues to look for work, for example.”
According to Wells Fargo, of the participants who took out loans, the greatest percentage were in their 50s (34.2%), followed by those in their 60s (28.9%) and then by those in their 40s (27.3%).
“One important thing to bear in mind,” Dai said, “is that older participants generally have much higher 401(k) balances than younger participants, giving them more of a resource to draw on when they do need a loan. In addition, this is the generation that is most commonly feeling the squeeze of paying for their children’s education and supporting aging parents.”
Nevertheless, the increased loan activity among older participants was deemed “concerning” by Laurie Nordquist, director of Wells Fargo Retirement. “Those are the years when workers can start to make ‘catch-up’ contributions and really need to focus on preparing for retirement,” Nordquist said in a statement, referring to the ability of workers 50 and older to contribute an extra $5,500 to their 401(k)s in 2013, bringing their maximum contribution to $23,000.
Taking a pre-retirement 401(k) loan also may lead to tax troubles. Borrowers who lose their job or leave their company are required to pay off such a loan in full, usually within a short time period. Those who can’t repay the loan will owe income tax on the outstanding balance and possibly a 10% early withdrawal penalty.
“We can’t give advice on loans but we can help people understand how they work,” Dai said. “Typically, at the time participants are taking a loan they are most interested in understanding how a loan works and how they’ll get the money, versus focusing on what happens if the loan is not repaid and the person is terminated or leaves the company.”
Financial advisors should be sure clients know all the potential consequences of borrowing from their 401(k)s, especially right before retirement. However, based on anecdotal reports from Wells Fargo call center representatives, if participants need to access their retirement savings and don’t have other places to get the money, they are going to take the loan.
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