New Bill Seeks to Limit 401(k) Access

While the legislation's heart might be in the right place, this provision would do more harm than good

Sometimes Congress means well, but only manages to make matters worse. A few politicians will hear of a problem and swiftly respond with new legislation that may help in some ways, but causes harm in others. This is the case with a new bill, a portion of which seeks to limit Americans' ability to tap into their 401(k) plans prematurely.

Not all provisions of this bill are bad. For example, one part of the bill seeks to allow 401(k) savers to make elective contributions in the months that follow a hardship withdrawal (currently, there's a six-month blackout period), which is probably fine. But here's the part that makes no sense: the bill would limit the number of outstanding 401(k) loans to three.

The bill was introduced on Wednesday by Senators Herb Kohl (D-WI) and Mike Enzi (R-WY). It's in response to a study that says about 28% of 401(k) participants have an outstanding loan against their account. The proposal intends to prevent "leakage," which occurs when people rely on their 401(k) before retirement and do not have enough money left over when they do retire to provide the amount desired. The proposal is said to also cut administrative costs.

Children Don't Have 401(k)s

For starters, children don't have 401(k)s: adults do. So why are they being treated like children? If it's their money, shouldn't they have ultimate discretion how and when they use it? Even though this money is intended for retirement saving, it is still an individual's savings, not the government's savings. These loans are ultimately paid back or treated as an early withdrawal that faces the usual penalty. So why should savers be forbidden to tap in early several times, if necessary? Although employers can have a say on how many loans they allow against their plans, the government should not.

What's the Alternative?

So let's say that you tapped into your 401(k) to help with your mortgage down payment back in 2007. In 2008, your kid got into Stanford, so you took another loan against your savings to help pay tuition. Later that year, your spouse got laid off, so you took another loan to cover day-to-day expenses. It wasn't enough, as your spouse remains unemployed, so you took out another loan in early 2010.

That last loan would now be forbidden under this new law. But someone in that situation has few other options. Do they apply for welfare instead? Or must they max out their credit cards -- which would require them to pay a much higher interest rate than another 401(k) loan? Do they foreclose? These options all seem rather absurd, considering that this person has accumulated savings prior to this hardship.

Really, What's the Point

The sponsors of this bill want to reduce leakage. Okay, but why? What's so bad about leakage? As mentioned, it's within a person's right to save as much or as little as they please. If the government wants to create a retirement program over which it has strict discretion of how and when people can withdraw, they can do so and call it something like "Social Security." Oh, wait.

The bill also seeks to lower administrative costs. There's an easy solution here: if it's true that having more than three loans causes administrative costs to increase, then charge an incremental fee that's proportional to that cost for each additional loan a person obtains. Problem solved; freedom preserved.

If the government wants to promote fiscal responsibility, then that's a laudable goal. But this isn't the way to do so. I haven't read any reports of people increasingly dipping into their 401(k) funds to vacation in Turks and Caicos. Almost all who need 401(k) loans are doing so for good reasons, like hardship. It makes no sense to limit access to their savings under such circumstances. Instead, it will just discourage 401(k) participation, because people will feel that they don't have as much flexibility over their savings.