Recs

3

This Government Meddling Could Save Your Retirement

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Nothing gets certain Fools exercised like the phrase "new government restrictions." So often, we hear that the busybodies in Washington or our state capitals are plotting some new set of limits and we get worried: Here comes more paperwork, more taxes, more annoyance, and less freedom to be left alone and live our lives in peace. And often, these worries are justified.

But I recently heard about a new set of freedom-limiting proposals that's making its way through Congress, and I cheered. Why? Because these new rules are targeting a privilege that has turned out to be a problem for many: 401(k) loans.

Not a ban, just an adjustment
First, let's get this out of the way: The bill introduced last week by Sen. Herb Kohl (D-WI) and Sen. Mike Enzi (R-WY) isn't going to do away with 401(k) loans. While these loans can be problematic and expensive (more on that in a minute), for many they're an important rainy-day resource. I think everybody recognizes that.

What the bill does do is limit some of the more egregious features, while making life a little easier for those who do take loans:

  • Limit 3 per customer. The number of people with three or more 401(k) loans outstanding is pretty small -- Fidelity says that only 0.8% of its 401(k) participants fall into this category -- but common sense suggests that those with lots of loans probably haven't been using their 401(k) as a last-ditch emergency fund. Those folks may need to tighten their belts: Under the bill, three loans at a time would be the maximum.
  • No more 401(k) debit cards. Yep, the worst financial idea ever may soon be gone. In keeping with the idea that a 401(k) loan should be an emergency fund and not a piggy bank, tools like this that encourage frequent and easy access will no longer be allowed.
  • More time to repay if you're laid off.  Under current law, if you're laid off while you have a loan outstanding, you have a mere 60 days to repay it before it's considered an early withdrawal, complete with tax penalties. Under the new rules, you'd have until the tax filing deadline for that tax year to repay the loan by contributing to an IRA, reducing your tax liability. This change is long overdue, I say.
  • Eliminate contribution restrictions after hardship. Under current rules, folks who take a hardship withdrawal can't contribute to their 401(k) again for six months. That prohibition would go away under the proposed new rules. Again, a good thing.

The idea, in other words, is to preserve the ability to tap one's 401(k) in a pinch while cleaning up some of the potential for abuse and making life a bit easier for borrowers. And while there's no question that the right to borrow from your 401(k) is a good one to have, I also don't think it's in question that some folks have gotten carried away with the loan privilege.

After all, a 401(k) loan can be awfully expensive.

An expensive tool of last resort
Most 401(k) plans allow participants to take loans, and in a crisis such a loan is often the least bad option. Fidelity Investments, one of the largest 401(k) providers, says that 22.1% of active participants in the plans they administer had at least one loan outstanding last quarter. These aren't trivial loans, either -- the average loan amount was almost $9,000, and many participants have multiple loans.

That's a lot of money to be taking out of the market. Think of it this way: For every $1,000 you had out of the market over the last two years, you would have missed more than $500 worth of growth in the S&P 500. And it gets worse if you have investments in your plan that outperformed the broader market.

In other words, the cost of a 401(k) loan can be very high, and it's mostly not about the interest you may be paying. In the long run, the lost returns from diverting money away from 401(k) investments are huge.

The upshot
I think these rule changes are long overdue. For most of us, this bill will be no big deal: Our right to take a 401(k) loan in an emergency isn't going anywhere. For most of those with outstanding loans, your life could get a bit easier if you're laid off.

But for those using their 401(k) as a sort of easy credit line, it might soon be time for them to tighten up their financial acts.

Get the government on the side of your portfolio. Check out this free report from Motley Fool analysts: "Too Small to Fail: Two Small Caps the Government Won't Let Go Broke."

Please, in the comments section below, tell us what you think of our coverage. How much does it matter to you?

Fool contributor John Rosevear appreciates your comments. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (1) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1500599, ~/Articles/ArticleHandler.aspx, 9/23/2014 12:43:23 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

John Rosevear
TMFMarlowe

John Rosevear is the senior auto specialist for Fool.com. John has been writing about the auto business and investing for over 20 years, and for The Motley Fool since 2007.

Today's Market

updated 3 hours ago Sponsored by:
DOW 17,172.68 -107.06 -0.62%
S&P 500 1,994.29 -16.11 -0.80%
NASD 4,527.69 -52.10 -1.14%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes


Advertisement