As plan advisers, our guidance might help increase a plan's overall participation and average deferral rate, but there is little we can do to help people when they're confronted with a large, unanticipated expense.
For some, this means dipping into an emergency fund; for others, whipping out the credit card or hitting up friends or family for cash. For a select group, it means taking a loan from their 401(k).
Advisers would prefer participants never take a 401(k) loan, but we also know that's unavoidable for some.
The good news is participants are starting to take fewer loans. As of end-2015, 18% of people eligible for loans had one outstanding. That figure was 20% in 2014, according to most recent figures from the Employee Benefit Research Institute. Following are a few strategies to help advisers continue that trend.
Legend has it Tabasco sauce executives, wondering how to generate more sales, came up with a simple-sounding solution: increase the size of the bottle's opening so more hot sauce comes out. That, in turn, would lead to more sales.
We can adopt the same logic with 401(k) loans, by decreasing the opening. I come across many plans that allow participants to take multiple loans at one time. To reduce loans, simply reduce the quantity participants can have at a time to one. You can, of course, remove the loan feature altogether, but that seems too drastic for most plans.
The reason many participants take loans is because they have no other forms of credit available to access. Fortunately, over the past few years companies have begun allowing employees to access credit through their employer without the employer being involved. Companies like Kashable and FinFit, for example, allow employees to access credit and pay back a loan via payroll deductions.
The advantage of these programs is they take the employer out of the situation of loaning money to their employees. And it lets employees avoid taking a loan from their 401(k), so they can continue making deferrals to their retirement plan.
The 401(k) industry has been so focused on getting participants to save in a retirement plan that it has overlooked opportunities to improve employees' current financial situation. That appears to be changing at a rapid pace.
For instance, Empower Retirement has a feature that allows participants to elect to save money in an emergency savings account via their 401(k) account. Educating participants on features like this (and getting participants to utilize them) will also help them avoid accessing 401(k)s for a loan.
The first step in any substance-abuse program is admittance. Unless individuals confront the fact that an issue exists and own it, they'll never be serious about correcting it.
Now, I'm not saying taking from a 401(k) is equivalent to a substance-abuse issue, but the essence of the first step is relevant. If we want to help employees avoid taking a loan we need to first help them understand why they have to take a loan to begin with. That's where a well-constructed and implemented financial wellness program with feedback loops and measurements comes in.
A good financial wellness program should allow employees to admit their weaknesses and educate them on ways to strengthen them.
The research on the impact of financial wellness programs is loose and will likely always be hard to pin down, but one thing is not: awareness opens the door to better decisions and that will hopefully lead to fewer 401(k) loans.
Aaron Pottichen is the retirement services president at CLS Partners, an Austin, Texas-based financial advisory firm.