Sub-prime and 401(k)

Should plan sponsors take action?

Between 2004 and 2006 various institutions made approximately $1.5 trillion in high interest rate loans, including the sub-prime loans currently making the news, according to The Wall Street Journal. The Journal’s analysis found that, contrary to expectations, such lending rose not only in low-income city neighborhoods but in middle-class and wealthy communities as well. How many of these borrowers will be facing foreclosure is unknown, but according to Irvine-based RealtyTrac Inc., a total of 223,538 foreclosure filings were reported in September, up from 112,210 in the same month a year ago. It is likely that many people facing foreclosure participate in 401(k) plans. Will they see their plan assets as a lifeline in desperate times, or will they stay the course and continue to save for retirement? 

It appears that some are looking to their defined contribution plan savings to help them. While there are no studies yet to indicate how many, I have received reports that plan loans and hardship withdrawals are increasing. The question for plan sponsors is this: Should we do something? Certainly, someone should take a hardship withdrawal only in the most extreme case. Not only do those who take a hardship withdrawal from their 401(k) plan incur a significant tax liability, they lose the bankruptcy protection afforded to their retirement savings. It is possible that someone who withdraws their retirement savings from their plan will still not have enough money to save their home. 

Perhaps this is an opportune time for a communications program explaining the bankruptcy protection provided to those with retirement plan savings — perhaps even something no more than a paragraph in the company newsletter. Few participants probably even know of this benefit. It is likely they learn of it only when they initiate a bankruptcy proceeding. 

Unfortunately, the sub-prime loan repayment problem could get worse. Many of those most challenged to make their mortgage payments have repayment schedules that will continue to increase the interest rate they pay for years. As time passes, more and more people could be affected. It is important that they not make an uninformed decision as they struggle through their crisis. Helping them understand what they are giving up when they take a hardship withdrawal from their 401(k) could protect them from what could be the ultimate tragedy: losing their home and their retirement savings as well.