Loans Often Necessary But Seldom Beneficial

Earlier this year Fidelity reviewed loan and withdrawal activity among 21,200 retirement plans and 13.5 million participants, finding loans are often viewed as an unavoidable financial necessity for those taking them.

Despite the perceived necessity, retirement savers almost never see a long-term improvement in the financial situation by choosing a loan or even a hardship withdrawal, Fidelity says.

Overall about one in 10 plan participants elected to take a loan last year, the research shows, with an average amount around $10,000. Hardship withdrawals occur even less frequently—drawn by about 2.2% of participants during the year-long sample period. Most often participants taking a hardship withdrawal cited medical expenses (19%) or the need to avoid foreclosure on a home (34%).

Part of what makes taking loans harmful for the long-term is that those who take one loan are likely to take at least one more in the future. While 50% of 401(k) borrowers take just one loan, the other 50% borrow multiple times, Fidelity says, and 10% go on to take a hardship withdrawal.

The reporting echoes earlier research, published by the National Bureau for Economic Research (NBER), which suggests when a plan sponsor permits multiple rather than only one loan, each individual loan tends to be smaller, but the probability of plan borrowing nearly doubles, and the aggregate amount borrowed rises by 16%. The researchers contend that this suggests employees perceive that easier loan access is actually an encouragement to borrow.

Perhaps unsurprising, Fidelity finds borrowers tend to save less on average over time after their first loan. For example, fully one in four borrowers reduced their savings rate within five years of taking a loan, generating $180 to $690 less per month in anticipated annuitized retirement income. Even more troubling, Fidelity concludes, 15% of those who take a loan go on to stop saving altogether within a fairly short period of time. 

These findings and others are presented in a helpful infographic here.