In the last two weeks, Sens. Pat Toomey, R-Pa., and Rand Paul, R-Ky., have floated legislative proposals that would allow retirement savers to raid their 401(k) plans to pay for long-term health insurance premiums or pay off student loans, respectively.
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First, let us acknowledge that these lawmakers are well-intentioned. But then let's call out these plans for what they are: shortsighted ideas that seemingly address one set of problems by exacerbating an even bigger one.
Mr. Toomey's plan addresses a very real issue. As Americans live longer, they are increasingly in need of long-term medical care. But the cost of such care is incredibly expensive. The median cost for a month's stay in a private room in a nursing home is $8,517, according to Genworth Inc. That's more than $100,000 a year.
Long-term care insurance can help pay for such care, but the premiums for LTC policies have skyrocketed and most Americans are not willing — or able — to pay for them. Alternatives for those needing long-term care include paying for it out of pocket or spending down their assets until they qualify for Medicaid. Neither is considered a smart way of dealing with the long-term care issue.
Enter Mr. Toomey and his plan to allow retirement savers to take up to $2,000 a year out of their 401(k) accounts or individual retirement accounts tax-free and penalty-free to pay for LTC premiums.
Let's move onto Mr. Paul's plan. Similarly, his plan would allow retirement savers to withdraw money from 401(k) funds or IRAs — up to $5,250 a year — tax-free and penalty-free to pay off student loans or finance a college education.
Like long-term medical care, student debt is a huge problem. Last year, the average college student owed nearly $30,000 after graduation, according to the Institute for College Access & Success. Studies have shown that college loan debt is having an adverse impact on the economy and is preventing young people from buying homes and starting families.
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While these legislative proposals make sense on one level, they create another potential hurdle for Americans — one that is even more troubling than either long-term medical care or student debt.
It is well documented that too many people are not saving enough during their working years right now and are entering retirement with insufficient funds to see themselves through the next 20 or 30 years of retirement. Both Mr. Toomey's and Mr. Rand's plans would make this situation worse.
Consider an employee earning $100,000 a year who is currently putting 10%, or $10,000, into his 401(k) plan. If he is allowed to divert $2,000 to pay for an LTC premium each year, he is saving only $8,000. Over a 20-year period, that's $40,000 less going into his retirement account, not even counting the lost investment opportunity of those funds.
If that same employee diverts $5,250 annually for six years to pay off roughly $30,000 of student debt, he will likewise have deprived his 401(k) account of that principal and investment potential.
The sad truth is that many Americans are already abusing their 401(k) plans. Through either hardship withdrawals or loans, they are raiding their accounts to pay for things that retirement savings plans should not be funding. Indeed, some people have turned their 401(k) accounts into piggy banks that they crack open to buy a car, go on vacation or redecorate their home.
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Rather than coming up with ways to further deplete retirement savings, legislators should be creating incentives for Americans to save more. There are other ways to address problems such as long-term health care and student debt without jeopardizing Americans' retirement security.
